Editor’s note:
　　This edition of Essence draws on from the report on China Everbright Limited （CEL） by TONGChengdun. Tracking its growth trajectory, we can find that China Everbright, a fully licensedfinanciaservice provider in both mainland China and HK, has already grown into an integratedcross-border investment platform supported by its distinctive business portfolio of passively heldstakes, managed fund and principainvestment.
　　Valuation and investment rating
　　Divestments of passively held stakes implies a valuation re-ratingIn reference to KKR’s PB and P/AUM （above 1.1x and 3.9% on average and peaked at 2.6x and20.1% respectively） since it went public in 2010, CEL deserves a fair valuation of above 1x PB ifit transforms into a pure asset management play.
　　The valuation discount is expected to be eradicated if it can divest stakes in China EverbrightBank and Everbright Securities and pay out dividends in fulduring 2017/18E.
　　CEL’s current market cap stands at HK$26.50bn while it was valued at HK$47.70bn for 2016based on a SOTP method （China Everbright Bank and Everbright Securities are valued basedon their latest market values on the A share market and the managed fund and direct investmentare valued at 1x PB respectively）， from which we derive a valuation discount of 55.5%.
　　Assuming the Company sells out stakes in China Everbright Bank and Everbright Securities andpay out dividends in fulduring 201/18E （excl. the capitagain tax） and the pure assetmanagement play after the business transformation trades at 1x PB, its return on investmentover the next two years is forecast to be 97%.
　　We apply 0.7x and 1x PB to stakes in China Everbright Bank and Everbright Securities and 1xPB to the Company’s managed fund and direct investment businesses and the PB-based SOTPvaluation for the Company wilbe HK$40.40bn, equivalent to a valuation discount of 65.6%.
　　Assuming the Company sells out stakes in China Everbright Bank and EverbrightSecurities and pay out dividends in fulduring 201/18E （excl. the capitagain tax） and thepure asset management play after the business transformation trades at 1x PB, its returnon investment over the next two years is forecast to be 79.3%.
　　Initiate OVERWEIGTH with the potentiaannualized return at 24%during 2017/18E
　　The Company could potentially embrace a valuation re-rating （which implies a potentialannualized return of 24%） if it divests the stakes in China Everbright Bank and EverbrightSecurities considering the clear willingness of the Everbright Group to go public. Based onthe conservative P/B valuation method, we value the Company at HK$40.40bn, assuming:
　　（i） 0.7x P/B for its stake in Everbright Bank; （ii） 1x P/B for its stake in Everbright Securities,fund management business and direct investment; （iii） based on forecasts made by theCompany for 2016. This translates into a target price of HK$24. Assuming a holding periodof two years, a valuation re-rating implies a potentiaannualized return of 24%.
　　Nevertheless, due to the uncertainties surrounding the progress of the divestments, weinitiate coverage with OVERWEIGHT.
　　Company profile: a diversified financiacompanypassively holding stakes in associates
　　A HK based diversified financiacompany held by the EverbrightGroup
　　A HK-based diversified financiacompany held by the Everbright Group, which, currently,the Everbright Group holds a totaof 49.75% of CEL’s shares outstanding.
　　Transforming its core business into trans-border asset management. During 1994-1999,CEL acquired 20% and 49% stakes of China Everbright Bank and Everbright Securitiesrespectively, becoming the first off-shore financiaholding company of China. In 2000, itforayed into the field of direct investment and sponsored its PE fund, the China SpecialOpportunity Fund I. Currently, CEL is a diversified financiacompany that focuses ontrans-border asset management and passively holds stakes of China Everbright Bank andEverbright Securities.
　　Business portfolio: passively held stakes （with market cap ofHK$27.90bn） + asset management plus investments withproprietary capita（net asset of HK$16.60bn）Stakes of China Everbright Bank （3.37%） and Everbright Securities （24.71%） that CELheld passively as of 2 March 2017 and 18 Jan 2017 respectively are fairly valued atHK$7bn and HK$20.50bn, adding up to HK$27.90bn.
　　Asset management and investment with proprietary funds: were equivalent to net assetsof HK$16.60bn with HK$67.80bn worth of managed funds offered as of 30 Jun 2016.
　　Asset management: its portfolio of funds include primary market, secondary market andmezzanine funds etc., via which it offers diversified financiaservices to clients from theAsia Pacific, Europe, the America etc. As of the end of June 2016, under CEL’smanagement were 33 actively managed funds and 89 investment projects, of which 16projects had already been listed on stock exchanges worldwide. It offered HK$67.80bnworth of managed funds, （+38.4% from the leveat the end of 2015）。 Of which, c. 52.8bnwere raised from clients, taking up 78% of the totawhile c. HK$15bn was its seed capital,accounting for c. 22% of the total.
　　Principainvestment （or direct investment）： CEL has supported the development of itsmanaged fund business via multiple means of investment, including investment into equity,bond, derivative etc. Its specific businesses include:
　　PE products （via seed capital, which amounted to c. HK$15bn as of 30 Jun 2016）Co-investment into the funds it established to strike a balance between itsprincipainvestment and managed fund businessesLong-term shareholding into financiaenterprises that 1） boasting long-termgrowth potentiaand 2） can generate synergies with its managed fund business.
　　Cash and cash equivalent （HK$5.3bn as of 30 Jun 2016）。
　　Financiaindicators: an average ROAE of 10.0% for the last 8 years due to the highlyvolatile returns from the equity market
　　Possible changes: to divest the stakes it passivelyholds in China Everbright Bank and EverbrightSecurities
　　The Everbright Group’s strategic goais to achieve whole-group listing as it completed therestructuring in 2015 after 11 years of efforts. To streamline the complicated shareholdingunder the umbrella of the Everbright Group, an inevitable step towards its whole-grouplisting, theoretically, CEL would divest its stakes of China Everbright Bank and EverbrightSecurities, two major profit contributors for China Everbright Group.
　　Starting from 2013, CEL has already divested parts of its stakes of China Everbright Bankand Everbright Securities. With the restructuring of Everbright Group completed, there isneither policy hurdle nor capitastrain for Everbright Group to take over the remainingstakes that CEL holds of China Everbright Bank and Everbright Securities.
　　The strategic goal: becoming a leading trans-borderwealth management platform
　　The strategic goaof expanding its managed fund business viatrans-border presence
　　CEL has already built up an integrated asset management platform for investors to engagein trans-border investments on. As a fully licensed financiaservice provider both in HKand the mainland China （as QFII, RQFII, QDII etc.）， CEL can offer products or makeinvestments in these two markets. As of the end of 2015, funds under the management ofCEL made investment worth of a totaof HK$37bn （c. HK$32.50bn in the mainland Chinaand c. HK$4.5bn in overseas markets）。
　　CEL’s managed fund business has been expanding in size as it has seized the strategicopportunities from the changes in the environment for cross-border investment.
　　Operationamodel: benchmarking against KKR, CEL aims tostrike a balance between its asset management business andbalance sheet
　　Benchmarking against KKR （whose capitamarket department （referred to as KCM） offerscapital/financing solutions for the projects that KKR invests in）， CEL aims to strike abalance between its asset management business and balance sheet. KKR has beendriven its fund management business through investment into relevant projects with itsproprietary capitato strike a balance among 1） third-party capital, 2） its own balance sheetand 3） KCM.
　　CEL has been helping investment teams stilat the growth stage to hatch PE fund in theform of seeding funds by boosting its low-cost liabilities appropriately on its lowliability/asset ratio. In 2016, it was approved to offer Rmb12.80worth of Panda Bond andoffered Rmb8bn of such bonds at the average cost of 2.9%-3.1%. As of 30 Jun 2016, itsliability/asset ratio stood at 36.1%. Its seeding funds amounted to c. HK$15bn, accountingfor 22% of the proceeds from offering managed funds. In addition, it also invested intofunds under its management via initiainvestment, co-investment etc., striking a balancebetween its principainvestment and managed fund businesses.
　　Expected to become a leading asset management platform ofChina
　　Fund-raising capability: Backed by support from Everbright Group, CEL has maderemarkable achievements in Mega Fund strategy. The Company has made remarkableachievements in its strategy of expanding the size of its managed fund business 1） backedby a） the Everbright Group’s background in the diversified financiauniverse and b） themodeof seed funding and 2） to meet the needs of medium/large institutionainvestorssuch as insurers and banks, among others, for allocating to alternative assets. It offeredfunds worth of HK$20.80bn during 1H2016 and is forecast to offer a totaof HK$30.60bnworth of products for fulyear 2017. In Jun 2016, CEL and IDG Capitasponsored togetheran industriainvestment fund （the Mega Fund） with totaregistered capitaof no less thanRmb20bn and completed the delivery of the initiatranche of Rmb10bn, to which theCompany has contributed Rmb2bn while the remainder Rmb8bn wilbe raised from otherlarge/medium institutions. In addition, CEL’s reaestate funds are expected to offerRmb10bn worth of products within 2017 and its FoF fund has been actively proceedingwith the second closing and is expected to complete the fund-raising for the initiatrancheof Rmb5bn within 2016.
　　Investing capability: starting from 2016, CEL began cooperating with peers at the GPlevefor greater synergies among alparties involved in terms of resources and investingcapabilities.
　　Divesting capability: CEL has diversified the ways of divesting from investment projectsby actively seeking for industriaconsolidations. CEL’s innovative ways of divesting frominvestment projects include:
　　Taking over lucrative investment projects that expire with new investingvehicles;
　　Injecting stakes of its investment funds into other ListCos; andAsset securitization, which accelerates the cash recovery.
　　Divesting passively held stakes conducive to takeoff of the assetmanagement business
　　Having traded below 1x PB continuously, CEL can’t replenish its capitavia refinancing,which has constrained it from seeking further development. Its valuation wilre-rate to fairleveif it divests the passively held stakes so that hurdles for its asset managementbusiness in the following three aspects wilbe removed:
　　It continuously needs seed capitato expand its asset management business and achieveeconomies of scale as the managed fund business wilrely on economies of scale to boostreturns for shareholders over the long run.
　　It wilalso rely on M&As backed by resources from the capitamarket to achieveeconomies of scale in its asset management business.
　　As talents are at the core of a player’s asset management business, institutionalarrangements for incentives are the strongest guarantees for retaining talents.
　　Potentiarisks
　　Disappointing progress in assigning stakes in China Everbright Bank andEverbright Securities;
　　Decline of the equity market results in decreased investment gain or adds to thedifficulties of exiting from these investment projects;The downward inflection point for liquidity supply and waning risk appetite add tothe difficulties in offering managed funds;Tightening controover foreign exchange bodes ilfor trans-border investment.
　　Assumptions and earnings forecast
　　Key assumptions: the totaproceeds from its managed fundbusiness are expected to keep growing by 20%+Earnings forecast: 2016-2018E ROAE forecast to be12.0%/8.2%/9.1%
　　We forecast CEL’s 2016-2018E attributable net profits to be HK$4.82bn, HK$3.49bn andHK$4.17bn respectively （-5.2%, -27.7% and +19.7%）， equivalent to 3-year ROAE of12.0%, 8.2% and 9.1% respectively.