This article first appeared in The Edge Financial Daily on October 2, 2018

DRB-Hicom Bhd
(Oct 1, RM2.14)
Maintain buy with a target price (TP) of RM2.80: Zhejiang Geely Holding Group Co Ltd (Geely) has entered into a licensing agreement of intellectual property (IP) with associate Geely Automobile Holdings Ltd (Geely Auto) (listed in Hong Kong), in which Geely is permitted to sub-license the IP to Proton Holdings Bhd (50.1% owned by DRB-Hicom Bhd and 49.9% by Geely) for the design, development, manufacture, sale, marketing and distribution of three models within the Southeast Asia region (excluding Indo-China) for 10 years (from the date of model production). The total license fee for the IP is 1.34 billion yuan (RM806 million), which shall be settled by Geely in five equal annual instalments over five years from the date on which the licensed period of the relevant licensed model commences.

Geely Auto has also agreed to sell completely-built-up units, completely-knocked-down units and related aftersales parts of the three models for a term of three years ending on Dec 31, 2020 to Geely, which in turn sells them to Proton for sale, marketing and distribution in Southeast Asia. The proposed annual sales caps for the three years ending Dec 31, 2020 are 399 million yuan, 3.8 billion yuan and 4.15 billion yuan respectively. The selling prices are determined based on a cost-plus margin of 5.83%. The settlement is within 90 days of product delivery.

We are positive about the development of Geely in becoming the intermediary between Geely Auto and Proton, indicating that Geely is becoming a financial backup for Proton and has strong commitment towards Proton’s strategic turnaround plan. We believe the cost incurred by Geely would be passed back to Proton with no additional or material charges. The agreements involve three models, including the widely-known upcoming launch of the Proton X70 sport utility vehicle (SUV) (Geely Boyue) in the fourth quarter and two yet-to-be launched new models — Geely SX11 (a smaller SUV model known as Geely Bin Yue) and Geely VF11 (a multipurpose vehicle model touted to replace Proton Exora).

Proton may need additional funding to finance its licensing and new model production as well as its new venture into the Chinese market. We believe financing would not be an issue, given the backing of Geely and recent major corporate exercises by DRB-Hicom to raise cash of RM1.2 billion by the end of 2018.

We maintain our “buy” recommendation with an unchanged TP of RM2.80. The new development with Geely has strengthened our view on Geely’s commitment in turning around Proton and establish it as a platform for Asean market expansion as well as penetration into China. — Hong Leong Investment Bank Research, Oct 1