Fuxing China announced its plans on 22 Dec (after market close) to acquire three companies, viz Fulong Zipper (“FZ”), Jianxin Weaving (“JW”) and Fuxin Electroplating (“FE”) for a total cash consideration of RMB372m. Both analysts (DMG and NRA) who covered Fuxing viewed this acquisition positively. Nevertheless, with reference to Table 1 below, it is apparent that the share price fails to perform.

Source: Ernest’s compilations

Fuxing is paying about 10x FY09 PE and 4x FY09 P/BV for the three companies. This does not sound cheap but management explained in the press release that the services provided by the companies are strictly regulated due to its pollutive nature. Management also highlighted that the PRC government is likely to restrict the issuance of new business licences in the dyeing and electroplating services. Furthermore these services are complimentary to Fuxing’s business and widen its earnings base. (More about the rationale for acquisition in the later paragraphs)

Management highlighted several reasons for the acquisition which are summarized below

All of these three companies have been providing their services to Fuxing. By acquiring them, Fuxing would be able to achieve operational synergies (such as control over the cost and quality of the products and services) and enhance its competitive advantage as clients would prefer a “one stop shop” instead of finding several firms to do their products.

Fuxing produces and sells finished zippers, zipper chains and zipper sliders. With the acquisition, it has opened additional revenue bases in the weaving, dyeing and electroplating industry in China. The three target companies registered a net profit for FY09 of RMB36.9m. If the acquisitions were approved around 2QFY11, then the acquisitions should have some contribution in 2011 and more significant contributions in 2012 and beyond. (Note: 9MFY10 net profit excluding tax refunds amounted to RMB48.5m)

Business for the three companies is expected to be promising in the long term due to the extant barriers to entry. According to management, China will limit the issuance of new waste discharge permits and establishment of new businesses in the weaving, dyeing and electroplating industry. Thus, competition would only be limited to existing players and not new entrants.

Besides the above points, I would hasten to add another important positive point as a result of these acquisitions.  

With this substantial acquisition which involves a capital outlay of RMB372M, it indicates that Fuxing’s large cash hoard of RMB716.4m as of 30 Sep is likely real as they are not drawing on any bank loans nor issuing new shares. Recall that some S chips which held a lot of cash were questioned by shareholders on whether the cash balance in the books are real. Thus, this would allay investor concerns on the authenticity of Fuxing’s large cash hoard.

According to Chart 1 below, average consensus analyst target price for Fuxing is around $0.27. Consensus dividend yield is estimated to be 4.1%. With these acquisitions and with their super durable zippers gaining traction, it seems like Fuxing has its work cut out for them in the next two years.

Source: Bloomberg (27 Dec 10)

This writeup has been amended from the initial version which was sent to clients recently.

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