Portek International: Coveted port play (DMG)

(BUY, S$1.23, TP S$1.56)

ICTSI’s offer for Portek undervalues the stock. On 1st June 2011, International Container Terminal Services, Inc (ICTSI) launched an unsolicited voluntary conditional offer to acquire Portek at $1.20/share, representing a 69% premium to the last traded price. The offer valued Portek at a historical P/E of 14.8x, significantly above its 2-year trading range of 3.5-8.6x P/E. While ICTSI’s offer appears attractive on a historical basis, we believe it undervalues the stock by as much as 30%. Portek has significant synergies and strategic value to ICTSI, and a successful acquisition would help the latter to meaningfully expand its footprints in fast-growing ports in Latin America and Africa where Portek is well-entrenched. ICTSI’s offer is conditional on it securing at least 50% of the outstanding shares by the close of its offer.

Portek’s businesses have excellent momentum and significant earnings upside. We believe Portek is poised to deliver robust earnings growth over a multi-year timeframe, with rising throughput and tariffs driving margin expansion at its port division as costs are relatively fixed. Tariff rates tend to increase at 10-15% per annum at its ports. With its track record of retrofitting ports and improving port productivity, it is well-positioned to win new port concessions. Case in point is Rwanda dry port, which the group clinched earlier this year. Meanwhile, the engineering arm plays a complementary role to the port division and improves its chances of winning new concessions. We forecast net profit CAGR of 28% over FY11-12.

Prospects of bidding war. Subsequent to the ICTSI offer, Portek announced that it is in talks with a third party which had expressed interest to make a bid of up to 100% for Portek. We believe this development significantly raised the probability of a bidding war between the 2 contenders. Portek’s ports are highly coveted given the scalability of its port operations and the growth potential of the emerging countries that it operates in. ICTSI has since amassed a 16.93% stake in Portek and the Securities Industry Council has ordered the potential third party to make its intention known by the 50th day of the despatch of ICTSI’s offer documents.

Fair value of $1.56/share. We derive a fair value of $1.56/share using a sum-of parts approach, valuing its port business at 14x, in line with its regional peers’ average. We observed that recent port deals are sealed at P/E multiples ranging from 20-26x. We value the engineering business at 10x P/E. Portek’s attractiveness as a takeover target and the potential 27% upside makes the stock compelling at current levels. Effectively, investors are paying a 2-3 cents option for the opportunity to partake in the upside of a higher offer price. The downside risk of the offer lapsing is mitigated by the undemanding valuation of the stock.