IT is no secret that Eastern & Oriental Bhd (E&O) was in dire need of a strategic partner for its 760-acre land reclamation concession in Penang — Seri Tanjung Pinang (STP) Phase 2. Funding the reclamation works primarily with debt is clearly unsustainable, especially with the looming 2022 deadline when the reclamation rights expire.

Hence, it was a major breakthrough last week when E&O announced that Kumpulan Wang Persaraan (KWAP) would be pumping in RM887.6 million into the group — RM766 million via land acquisition and RM121.6 million via the issuance of new shares.

KWAP’s move will put STP Phase 2 back on solid ground. The project fronting the sea is situated along Penang’s northeast coast, between George Town and the Batu Ferringhi beaches.

Nonetheless, investors were quick to sell on the news, pushing E&O’s share price down 8.9% to close at RM1.93 last Friday.

This values E&O at a 68% discount to a revised net asset value (RNAV) of RM6.10 per share, based on estimates by AffinHwang Capital.

But looking ahead, what does the KWAP deal mean for E&O?

For starters, the money KWAP is bringing in should be more than enough for E&O to complete the entire land reclamation for STP Phase 2A, which encompasses 252.8 acres.

STP Phase 2 is divided into three parts — Phases 2A, 2B and 2C — with each making up about one third of the 760 acres.

The total cost of reclaiming Phase 2A is estimated to be RM1.8 billion. This includes infrastructure like roads, utilities and the bridges connecting the man-made island to Penang Island.

Of the 252.8 acres, 65% or 165.9 acres is the net land available for development. KWAP is going to acquire 20% or 33.2 acres of the 165.9 acres for RM766 million or RM530 psf.

Right off the bat, this infers a floor valuation for STP Phase 2. Assuming 65% of the 760 acres is usable for development, the total land value of STP Phase 2 should be at least RM11.4 billion. This does not take into account the land reclamation cost.

The reclamation of Phases 2B and 2C is expected to cost about RM2.4 billion (RM110 psf) based on a conservative estimate — a little cheaper because the heavy infrastructure costs are borne in Phase 2A. Hence, the estimated total cost for STP Phase 2 is RM4.2 billion, giving the entire STP Phase 2 a net value of about RM7.2 billion.

E&O has a 78.78% stake in STP Phase 2, which is held under Tanjung Pinang Development Bhd.

“We have a strong ‘buy’ call on E&O as the current share price implies zero value for its STP2 project. We believe KWAP’s purchase of STP 2A land sets a benchmark price to support the new RNAV per share estimate of RM6.10. Our target price is RM3.05 based on a 50% discount to RNAV,” AffinHwang Capital states in a report last Friday.

This rides on the assumption that E&O can not only monetise this huge potential land bank, but also reclaim it before the 2022 deadline.

To this end, the company is expected to seek more partners to quickly monetise Phase 2A so that the capital can be rolled over to fund reclamation of Phase 2B. Of course, finding another partner might not be so easy, given the softening property market.

However, as part of the deal, KWAP has been given the first right of refusal to take a 20% interest in the development and sale of Phases 2B and 2C.

On top of that, KWAP is also taking a stake in E&O via the proposed restricted issue of 66 million new shares that will raise about RM121.6 million for the group.

The shares make up a 5.26% stake in E&O and will be issued at between RM1.84 and RM1.94 per share. Post-exercise, KWAP will have a 5.52% stake in E&O.

Meanwhile, Sime Darby Bhd’s stake will be diluted to 9.44%, while executive deputy chairman Datuk Seri Terry Tham’s holdings will be reduced to 17.42%.

Sime Darby used to hold a 22% stake in E&O, but sold a 10% stake back to Tham at RM2.45 apiece last year.

Looking ahead, it is unlikely that E&O can deliver substantial earnings over the next two years. The reclamation works for Phase 2A are only expected to be completed in early-2019 and the first launch of property in late-2019.

Furthermore, the group’s balance sheet will be tied up in the reclamation of Phases 2B and 2C that must start soon if E&O hopes to meet the 2022 deadline.

The good news is that E&O will use RM306.4 million of the proceeds from KWAP to reduce its borrowings. E&O had incurred RM1.08 billion worth of debt to fund the reclamation of STP Phase 2A.

Currently, the group has a net debt of RM1.2 billion and a net gearing of 73.65%.

KWAP’s funds will reduce E&O’s net gearing to an estimated 41%. In total, it will also generate interest savings of RM15.78 million a year.

For perspective, E&O’s 12-month net profit ended December last year was RM22.76 million.

In summary, it will still take some time for E&O to digest the massive STP Phase 2 project. But with KWAP now in the picture, E&O has a better chance of completing the project with less stress on its balance sheet.

With earnings only expected to pick up in 2019 onwards, the catalyst for E&O in the short term will be other strategic partners joining the project.

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