Bank of East Asia 23 HK
November 23, 2008 - 9:33am EST by
fw51
2008 2009
Price: 14.58 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 3,150 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Bank of East Asia (23 HK)

# of shrs o/s: 1.7bn

Price: HK$15.28

 
At current price, BEA's core HK banking business is essetially trading at half of that business' tangible book value, if excluding Triocor, Blue Cross and its China banking business, a tremendous discount even among the beaten down banking names in HK/China. I believe at this price level, BEA is an attractive investment to play 1) China's growth; 2) potential M&A upside.
 
At end of June 2008, BEA had a tangible book value of just under HK$15/shr. The majority of BV sits on its HK and China banking business. Despite having little book value contribution, its Tricor and Blue Cross could be worth HK$3-4/shr. Its China operation could be worth another HK$4/shr. As a result, the remaining core HK banking business is currently valued by the market at just half of its tangible book value.
 
It's noted that this report doesn't analyze the core HK banking business in great detail, partly because the writer doesn't have enough insight into their loan book to assess its asset quality. Nevertheless, remember this is a bank already hurt badly by its trading losses and exposure to some exotic papers. So there is good reason to believe it's largely priced in.
 
 
Sum-of-the-parts valuation
 
 
I. Tricor: HK$2-3/shr

II. Blue Cross (Asia Pacific): HK$1/shr

III. China operation: HK$4/shr (1x P/B on 25% of its tangible BV @ HK$14+/shr, excluding Tricor & Blue Cross)

I + II + III => HK$7-8/shr (BEA stock hit HK$7-8 last time during the last Asian Crisis back in '98; however, at that time, it didn't have much China presence, neither Tricor business)

 
 
Business Analysis
 
 
 
I. Tricor

A corporate services/share/custody/corporate secretariat and accounting services businesees, Tircor was built up through the purchases of these units from the Big Four accounting firms post-Enron/Worldcom scandals, at which point the accounting firms were forced to divest non-core businesses that could have inherent conflicts of interest with the core auditing function.  It has also continued to acquire similar operations elsewhere in the region, including Thailand, Malaysia and Singapore.

BEA owns 75% of Trior, with New World Group as minority shareholder. Tricor has 60% market share in Hong Kong in terms of number of listed corporate customers (its share is lower in value terms). The only major player is Computershare (40% of customers, but higher in value terms, and only involved in share registration part of the business).

The volatility of the business comes from two sources: 1) IPO activity: collecting HK$13 for each share of IPO issuance; 2) M&A. IPO benefit far outweighes M&A impact. With the redcued IPO actiivity, its 1H08 fee income was HK$400mm, or running at HK$800mm/yr, 20% lower than '07 level of HK$1bn (a good year for IPO). This business has 40% gross margin. At 16% tax rate and 1.7bn shares, even at depressed fee income level, Tricor generates over HK$250mm net profit, or 15c/shr. In a good year, it could earn 20c/shr profit. Growing at 20% over the cycle, at low-teen to mid-teen P/E multiple Tricor could be worth HK$2-3/shr to BEA.

Tricor doesn't carry too much book value on BEA's balance sheet, probably just HK$200mm, out of over HK$30bn equity.

 
 
II. Blue Cross (Asia Pacific)

Mainly medical insurance, sold to non-government/commerical entities (citing CHeung Kong among its clients). Started life insurance business 18 months ago. Growth has been good. Made pretax profit HK$100m in the first half of 2008. ON annualized basis, Blue Cross could earn 10c/shr or another HK$1/shr value to BEA.

 
 
III. China banking business

% of total assets: 25%

% of profit contribution: 30-35% (on normalized basis, excluding one-time items such as trading loss, write-off, etc.)

25% of customers are from strictly defined HK-based customers, however they contribute to majority of total earnings.

 

Asset mix (loan book) in China

Property development & construction loans: 12%

Mortgage: 7-9%

Property investement (shopping mall, etc.): 26%

Hotel: 7% (only 5-star)

Total hotel & property exposure: 50-55%

 

Wholesale and retail trade: 22%

Manufacturing: 9% (also a lot to do with exports)

Total exports related exposure: 30+%

 

BEA mgmt admitted the exports-related area is the most vulnerable given the worsening L/C market condition.

The current guidance of China loan growth is 35% for '08 and another 25% for '09. A lot of '09 growth is already built in the project pipeline - unless there is cancellation. 

Loan-to-deposit ratio in China's operation, which was incorproated within China, is at 130%, down from previously 350%, and is expected to decline to 75% eventually. BEA is expanding deposit base in South China more aggressively since that's where it can find money, but it is lending more in North China.

My due diligence work indicated that BEA has the best management team among all the foreigner banks, which is a dramatic contrast to its HK operation, which many investors view as mediocre.

 
IV HK banking business (actually has 7-8% profit from overseas other than China, most of which is generated in Singapore)
 
No growth/mature market. Fee income is the only few sources for any growth but fee income growth in the near term will be capped by the capital market weakness. HK asset/loan mix looks similar to China's - retail is believe to represent 14% of total.

 

The group has a ROE target of minimum 14%. In China, during the 1H08, ROE already reached 11%. For HK, normal ROE should be 15%, 65-70% of which is earned from NIM. The deposit has returned to 70% of pre bank-run level. Credit cost is expected to rise by 35-50bp but in the last Asian financial crisis ('98), credit cost once rose by 150bp. Citigroup is the most bearish analyst on the Street and he has 100bp rise in credit cost built into his '09EPS est. of below HK$1.50/shr.
 
 
Family still owns 30% of total shares, with Bank of China owning under 5% and Spanish bank Criteria Caixacorp owning under 9.72%. The Chairman/CEO David Li is 67 and has two sons working in the bank (one as head of corporate banking, and the other as head of wealth mgmt), both of whom are under forty. So unless forced, there will unlikely be sales - however, given the stock price where it is, a partial sales or JV plan is still possible. The lure of BEA is with its fast growing China operation, an appealing factor for any western bank who doesn't build up the infrastructure in China yet.

 

Catalyst

1) generally better sentiment toward HK-based banks, most likely to be driven by a growth reaccelerating in China;
2) potential M&A
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    Description

    Bank of East Asia (23 HK)

    # of shrs o/s: 1.7bn

    Price: HK$15.28

     
    At current price, BEA's core HK banking business is essetially trading at half of that business' tangible book value, if excluding Triocor, Blue Cross and its China banking business, a tremendous discount even among the beaten down banking names in HK/China. I believe at this price level, BEA is an attractive investment to play 1) China's growth; 2) potential M&A upside.
     
    At end of June 2008, BEA had a tangible book value of just under HK$15/shr. The majority of BV sits on its HK and China banking business. Despite having little book value contribution, its Tricor and Blue Cross could be worth HK$3-4/shr. Its China operation could be worth another HK$4/shr. As a result, the remaining core HK banking business is currently valued by the market at just half of its tangible book value.
     
    It's noted that this report doesn't analyze the core HK banking business in great detail, partly because the writer doesn't have enough insight into their loan book to assess its asset quality. Nevertheless, remember this is a bank already hurt badly by its trading losses and exposure to some exotic papers. So there is good reason to believe it's largely priced in.
     
     
    Sum-of-the-parts valuation
     
     
    I. Tricor: HK$2-3/shr

    II. Blue Cross (Asia Pacific): HK$1/shr

    III. China operation: HK$4/shr (1x P/B on 25% of its tangible BV @ HK$14+/shr, excluding Tricor & Blue Cross)

    I + II + III => HK$7-8/shr (BEA stock hit HK$7-8 last time during the last Asian Crisis back in '98; however, at that time, it didn't have much China presence, neither Tricor business)

     
     
    Business Analysis
     
     
     
    I. Tricor

    A corporate services/share/custody/corporate secretariat and accounting services businesees, Tircor was built up through the purchases of these units from the Big Four accounting firms post-Enron/Worldcom scandals, at which point the accounting firms were forced to divest non-core businesses that could have inherent conflicts of interest with the core auditing function.  It has also continued to acquire similar operations elsewhere in the region, including Thailand, Malaysia and Singapore.

    BEA owns 75% of Trior, with New World Group as minority shareholder. Tricor has 60% market share in Hong Kong in terms of number of listed corporate customers (its share is lower in value terms). The only major player is Computershare (40% of customers, but higher in value terms, and only involved in share registration part of the business).

    The volatility of the business comes from two sources: 1) IPO activity: collecting HK$13 for each share of IPO issuance; 2) M&A. IPO benefit far outweighes M&A impact. With the redcued IPO actiivity, its 1H08 fee income was HK$400mm, or running at HK$800mm/yr, 20% lower than '07 level of HK$1bn (a good year for IPO). This business has 40% gross margin. At 16% tax rate and 1.7bn shares, even at depressed fee income level, Tricor generates over HK$250mm net profit, or 15c/shr. In a good year, it could earn 20c/shr profit. Growing at 20% over the cycle, at low-teen to mid-teen P/E multiple Tricor could be worth HK$2-3/shr to BEA.

    Tricor doesn't carry too much book value on BEA's balance sheet, probably just HK$200mm, out of over HK$30bn equity.

     
     
    II. Blue Cross (Asia Pacific)

    Mainly medical insurance, sold to non-government/commerical entities (citing CHeung Kong among its clients). Started life insurance business 18 months ago. Growth has been good. Made pretax profit HK$100m in the first half of 2008. ON annualized basis, Blue Cross could earn 10c/shr or another HK$1/shr value to BEA.

     
     
    III. China banking business

    % of total assets: 25%

    % of profit contribution: 30-35% (on normalized basis, excluding one-time items such as trading loss, write-off, etc.)

    25% of customers are from strictly defined HK-based customers, however they contribute to majority of total earnings.

     

    Asset mix (loan book) in China

    Property development & construction loans: 12%

    Mortgage: 7-9%

    Property investement (shopping mall, etc.): 26%

    Hotel: 7% (only 5-star)

    Total hotel & property exposure: 50-55%

     

    Wholesale and retail trade: 22%

    Manufacturing: 9% (also a lot to do with exports)

    Total exports related exposure: 30+%

     

    BEA mgmt admitted the exports-related area is the most vulnerable given the worsening L/C market condition.

    The current guidance of China loan growth is 35% for '08 and another 25% for '09. A lot of '09 growth is already built in the project pipeline - unless there is cancellation. 

    Loan-to-deposit ratio in China's operation, which was incorproated within China, is at 130%, down from previously 350%, and is expected to decline to 75% eventually. BEA is expanding deposit base in South China more aggressively since that's where it can find money, but it is lending more in North China.

    My due diligence work indicated that BEA has the best management team among all the foreigner banks, which is a dramatic contrast to its HK operation, which many investors view as mediocre.

     
    IV HK banking business (actually has 7-8% profit from overseas other than China, most of which is generated in Singapore)
     
    No growth/mature market. Fee income is the only few sources for any growth but fee income growth in the near term will be capped by the capital market weakness. HK asset/loan mix looks similar to China's - retail is believe to represent 14% of total.

     

    The group has a ROE target of minimum 14%. In China, during the 1H08, ROE already reached 11%. For HK, normal ROE should be 15%, 65-70% of which is earned from NIM. The deposit has returned to 70% of pre bank-run level. Credit cost is expected to rise by 35-50bp but in the last Asian financial crisis ('98), credit cost once rose by 150bp. Citigroup is the most bearish analyst on the Street and he has 100bp rise in credit cost built into his '09EPS est. of below HK$1.50/shr.
     
     
    Family still owns 30% of total shares, with Bank of China owning under 5% and Spanish bank Criteria Caixacorp owning under 9.72%. The Chairman/CEO David Li is 67 and has two sons working in the bank (one as head of corporate banking, and the other as head of wealth mgmt), both of whom are under forty. So unless forced, there will unlikely be sales - however, given the stock price where it is, a partial sales or JV plan is still possible. The lure of BEA is with its fast growing China operation, an appealing factor for any western bank who doesn't build up the infrastructure in China yet.

     

    Catalyst

    1) generally better sentiment toward HK-based banks, most likely to be driven by a growth reaccelerating in China;
    2) potential M&A

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