2. How to determine the right valuation for OCK Group? [PART 2]

In order to unlock the entire value of OCK Group, the Group MD Sam Ooi Chin Khoon (OCK) is planning for a spin-off listing of its tower business (towerco) on a foreign stock exchange by 2020.

1. What is a spin-off listing?

Spin-off are divisions of OCK Group (i.e. towerco business) that become independent business. Employees with skills expertise in towerco industry and existing assets owned by OCK South East Asia Towers Pte Ltd (OCKT), 100% owned subsidiary of OCK Group will be transferred out from the parent company, OCK Group.

Shareholders of the parent company will receive equivalent shares in the company in order to compensate for the loss of equity in the original OCK Group's shares. However, shareholders may then buy and sell stocks from either company independently. 

2. Why is there a need to spin-off?

In normal circumstances, spin-offs allow high growth divisions such as towerco business to command higher valuation multiples once separated from the parent company.

With the total debt of RM480 million which majority of the amount is used to build its tower portfolio and lease liabilities of RM160.5 million, the company will incur huge interest expenses amounting to RM32 million. 

Depreciation has also increased throughout the year aligned with the expansion of towerco business to regional market such as Myanmar and Vietnam, the depreciation charge has increased from RM12 million in 2016 to RM62.6 million in 2019, an increase of more than 400% which eventually dilute the EPS. 

Both events would definitely lower down the profitability of OCK Group. With the ongoing expansion plans in place such as 5G, NFCP, and regional diversification to Philippines market, the towerco business will be expecting to incur more capital expenditures going forward. However, we know that the small seed you plant today will become a big tree tomorrow. While dominating the towerco space in Vietnam and Myanmar to be one of the largest telco tower provider in respective countries, OCK Group will benefit from the recurring income from tower leasing business.

Given the implementation of NFCP and further spectrum allocation for 700 Mhz, 3,500 Mhz and 2,600 - 2,800 Mhz in 2020, this would eventually translate to more jobs allocation for OCK Group as MNO players would need to undertake network deployment for the new spectrum bands. Recall from FY2016 and FY2017, revenue contribution from telecommunication network services segments of OCK Group has increased substantially following from reallocation of 900 Mhz and 1,800 Mhz spectrum among 4 incumbent mobile operators.

It is also expected that the towerco business will incur huge capital expenditure moving forward to cater for the growth in the telecommunication networks industry especially towards a new capex cycle required for 5G sites deployment.

3. Is there any impact on OCK Group from the Covid-19 outbreak?

Based on the interview with Group MD Ooi Chin Khoon which was published in The Edge Weekly 20 April 2020, he mentioned that there is no significant impact on its earning for the first quarter of 2020. However, there might be some delay in projects in near future. 

Mr. Ooi also pointed out that the spin-off is still in the pipeline, but it will be increasing its tower portfolio to a sizeable number before doing so. 

Currently the tower count of OCK Group stands at 4,200 towers. My view is that the spin-off will be announced once OCK managed to build a tower empire of 5,000 towers which will provide stable recurring income moving forward.

4. How do we value a spin-off divisions and the remaining segments of OCK Group?

According to Alliance DBS Research, the EV multiples that is usually ascribed to tower business is in the range of 11x to 13x.

Based on edotco's secondary share placement to Khazanah in 2017, the valuation is transacted at 12.5x EV/EBITDA. edotco is the largest independent towerco in Malaysia and is the most comparable towerco to OCK Group's tower business. According to RHB Research Institute, based on 12.5x multiples, the sale of OCK Group's towerco business could potentially unlock 13 to 35 sen per OCK's shares.

Since the edotco's share placement transacted at a 12.5x multiples which falls within the range of 11x to 13x, we can perform a sensitivity analysis based on the valuation.

The enterprise value of OCK Group is calculated as follows:

average 3-year EBITDA = RM113.4 million

Enterprise value of OCK Group = EBITDA * EV/EBITDA multiples

I have done a sensitivity analysis based on 11x to 13x of EV multiples. After arriving at the enterprise value, net debt and minority interest which do not belongs to equity investors have to be eliminated to arrive at equity value.

Then, indicative value is derived by dividing the equity value by the outstanding number of shares. 

At present, OCK Group's share price as of 29 April 2020 is 49.5 sen. Based on the sensitivity analysis performed above, there is an upside ranging from 40% to 88% which is above standard margin of safety of 30%. 

The indicative value or the target price is in the range of 69.4 sen to 93.1 sen based on 11x to 13x of EV/EBITDA multiples.

All information provided here should be treated for informational purposes only. It is solely reflecting author's personal views and the author should not be held liable for any actions taken in reliance on information contained herein.

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