China Water Affairs (the "Company", 00855 HK) announced that to align with the national call for low-carbon green development as well as to upgrade the Company’s water supply services and full development of its direct drinking water business, the Company proposes to spin off and seek separate listing of its city direct drinking water and water supply operation and construction business ("the spin-off business") on the Main Board of HKEX. The Company will undergo reorganization, such that group companies engaging in the spin-off business will be held under the Company to be spun-off ("spinco"). The spinco will continue to remain as a subsidiary of the Company and the Company is expected to own approximately 82% of the spinco after the spin-off. The Company considers that the spin-off is beneficial in the following ways: 1) unlocking potential value of the Spinco; 2) enhancing focus and clarity of the spin-off business and the remaining business; 3) the shareholder base for the Company as a whole is expected to be diversified and strengthened after the proposed spin-off; 4) a unique opportunity for the Company to raise equity financing; and 5) enhancing fund raising flexibility.
According to the Company’s FY22 interim report, the remaining business (mainly environmental protection and real estate businesses) and spin-off business (mainly city direct drinking water and water supply operation and construction business) accounted for 20.5% and 79.5% of the Company’s total revenue, respectively. After the spin-off, CWA (00855 HK) will still hold approximately 82% of the equity in the spinco, which still meets with the conditions for all sufficient business foundations requirements to maintain its listing status. In addition, the spin-off will give the Company more time and resources to sort out the remaining environmental protection and real estate assets, and further release the Company’s value. In addition, we estimate that the rapid growth of direct drinking water business in the next five years may require annual capital expenditure of RMB2 billion to RMB3 billion, and city water supply business will also require annual capital expenditure of RMB1 billion to RMB1.5 billion, which, if supported only with debt financing, is not ideal. Separate listing of the city direct drinking water and water supply operations and construction businesses not only can obtain a new financing platform to support the continuous development of the business, but can also acquire new funds to in turn reduce the overall debt ratio and help improve the Company’s bond issuance rating and reduce the cost of debt issuance, which will improve the Company’s profitability. We think that the spin-off will be hugely beneficial to the Company.
We think under the continuous driving of urban-rural integrated water supply and other policies, the Company’s room for growth in low-tier cities is still abundant. The Company can get more construction and connection services income. In addition, the Company’s direct drinking water business is rapidly expanding and will become a new growth driver. The spin-off might drive a new round of growth of the Company. Current valuation of under 6.0x FY2023 PER appears very low. We maintain the TP at HK$11.50, or 6.5x/ 6.0x/ 5.5x FY22/ FY23/ FY24 EV/EBITDA. Reiterate "Buy".