We think the potential acquisition of Languang Juston (2606 HK) would be positive for CGS as 1) strategically, Languang’s strong presence in Southwest (60% of managed GFA) would fill the gap for CGS (only 3% in the region). 2) Financially, the acquisition would boost CGS 2021/22E earnings by 20% if assuming 100% stake acquisition. Also, the two companies share similar profitability and thus there is less likely margin dilution. 3) Valuation wise, CGS is trading at 28x 2022E PE vs. Languang’s 5.4x. This would be value accretive even if we assume acquisition price has 30% premium to the last trading price. 4) Balance sheet wise, there’s enough cash to support up to 100% stake acquisition.
- What’s new: CGS and Languang halted trading on 23 Feb before market open. According to the Economic Observer, CGS would propose to acquire Languang listco but the news did not disclose the total consideration nor stakes to be acquired.
- Strategically 1+1>2: As of 1H20, Languang had a total managed/contracted GFA of 89.9mn/140.7mn sq m. The acquisition may further cement CGS’s No.1 position to reach contracted GFA of 1.3bn sq m in 2021E. More importantly, CGS has less penetration in Southwest region (only 3% of total managed GFA) and thus the acquisition of Languang (60% of managed GFA in Southwest region) would help expand this coverage. We believe CGS could also bring efficiency improvement when it comes to consolidation as Languang previously expanded heavily via M&A (44% of total managed GFA).
- We think it could be value-accretive for CGS: From the valuation perspective, currently CGS is trading at 28x 2022E PE vs. Languang’s 5.4x. Even if we assume the proposed acquisition price has 30% premium to the last trading price, the valuation is still below CGS and thus it would be value accretive. Also, the acquisition would boost its 2021/22E earnings by 20%/20% with little margin dilution given that two companies share similar profitability.
- Balance sheet can support up to 100% acquisition. As of 1H20, CGS had a cash of RMB9.9bn and we expect to increase to >RMB10bn by end of 2020E. This is enough to pay for up to 100% stakes acquisition of Languang with price premium of 30% to last price, which equals to RMB7.3bn. As pending for the official announcement, we do not exclude the possibility of partial stake acquisition, which may free more cash for VAS-related acquisition.
- Implication for the industry: there could be more of similar M&As in the future as 1) small players are losing market shares (even for those Top 30-50). 2) Competition gets more intensive together with parentco sales slowdown. 3) Huge valuation divergence between small and large players (difference as wide as 10-20x). We may see more small players with less parentco support to be acquired in the future.
