Related party transaction with parent

■ Powerlong CM announced plans to acquire an office building from parent for
Rmb868m. The transaction requires shareholder and regulator approval.
■ We think that the reasons for this related party transaction are weak and
could lead to corporate governance related concerns.
■ It lowered revenue and profit growth guidance by 5% for FY22F due to rising
Covid cases.
■ We cut our PEG-based TP by 57% to HK$6.50 which implies a target 5.7x
FY22F P/E and suggests 23% upside potential. Retain Add.

Plans to acquire office building from parent for Rmb868m

Powerlong CM announced late last night (11 May 2022) plans to acquire an office building
from parent, Powerlong Real Estate (1238 HK, NR) for Rmb868m. Located in Baoshan
district, Shanghai, it is a 24-storey office building with GFA of c.35k sqm, which suggests
ASP of Rmb24.8k/sqm (click here for announcement). As it is a related party transaction,
it requires approval from the Stock Exchange and minority shareholders, who we believe
could vote against the transaction due to the weak reasons given in the next paragraph.

Reasons for the transaction

Management hosted a conference call on the proposed transaction this morning (12 May
2022) and provided these reasons for the deal: 1) two floors of the office building are for
own use, 2) the asset offers stable recurring income growth in the long run, 3) it offers
rental yield of about 3%, which is a higher return than putting cash in the bank, and 4)
good outlook for the office property market in China. Management expects rental income
of about Rmb28m/Rmb28/Rmb32m in FY22F/FY23F/FY24F and added that Rmb868m is about 5% discount to valuer’s valuation.

5% lower revenue and profit growth guidance in FY22F on Covid

Management lowered its revenue/profit growth guidance by 5% pts to 25%/35% due to the
Covid spread in China. Hence, we cut our FY22-24F EPS estimates by 4-6%.

We are disappointed about the proposed transaction

Overall, we are disappointed about the transaction due to 1) corporate governance
concerns related to its expensive pricing of 50x FY22F P/E based on our 50% assumed
net margin for this related party deal, 2) deviation from its asset-light business model. In
our view, the company could better utilise its extra cash by 1) raising dividend payout, or
2) conducting share buybacks or M&A.

Cutting TP by 57% to HK$6.5; retain Add on attractive valuation

We cut our PEG-based TP by 57% to HK$6.50 as a result of 1) lower EPS CAGR of 23%
(previous: 25%) and lower PEG multiple of 0.25x (previous: 0.5x) due to lack of clarity on
the rationale for the announced deal and potential corporate governance concerns. The
new TP suggests 23% upside potential. Maintain Add on attractive valuation. Please refer
to risks on page 2.