HK blue chip finds Europe hard to resist

Hutchison Whampoa to exit some core businesses and push ahead with overseas M&As to drive growth

Acquiring low-priced overseas assets and exiting some mature businesses is Hong Kong-based conglomerate Hutchison Whampoa's strategy to maintain sustained growth for the year.

The blue chip group, controlled by tycoon Li Ka-shing, had reported this month a better-than-expected net profit during the first six months, with interim profit up 23 percent to HK$12.4 billion ($1.6 billion; 1.2 billion euros) from HK$10.1 billion during the same period a year ago, and also higher than the HK$10.8 billion median estimated by analysts.

The result has mainly been attributed to the company's diversification strategy, with overseas markets becoming a major source of revenue and profit.

During the first six months of the year, Europe accounted for more than 43 percent of HWL's revenue compared with 41 percent during the same period a year ago. The revenue contribution from Hong Kong, on the other hand, slipped from 16 percent in 2012 to 15 percent this year.

The earnings before interest, taxes, depreciation and amortization, or EBITDA, further reiterated the importance of the European market to HWL. The European region provided 35 percent of the EBITDA for the company, up from 32 percent a year ago. Hong Kong's contribution rose by 1 point to 15 percent.

HWL chairman Li Ka-shing, said in the earnings statement: "The company would be agile in seizing investment opportunities for long-term growth and achieve new growth through the continued pursuit of quality investments both in Hong Kong and abroad to create further value for shareholders."

As the global economy seems to be set in a recovery trajectory, it appears that Li is betting on proactive overseas asset acquisitions to secure the conglomerate's future profit growth potential.

The possible sale of his Hong Kong supermarket chain is a good case in illustrating this point.

HWL said on July 20 that it is conducting a strategic review of its PARKnSHOP supermarket retail business, which had approximately 345 stores in Hong Kong, Macao and the mainland and had revenues of HK$21.7 billion ($2.8 billion) in 2012, to optimize shareholder value.

"The cash flow contributed by the PARKnSHOP retail grocery business to the HWL group is already low, and its profit contribution to the conglomerate has also declined to single-digit growth. The investment return on PARKnSHOP retail grocery business has peaked," says Castor Pang, head of research at Hong Kong-based brokerage Core Pacific-Yamaichi.

"Cashing the PARKnSHOP grocery retail asset and using the proceeds to invest in relatively cheap European assets can help HWL to leverage greater asset valuation growth potential," Pang says in his research report on the group.

Though PARKnSHOP is one of the dominant supermarket chains in Hong Kong, the city's retail grocery market is already saturated so market growth potential is limited.

Jardine Matheson-controlled Wellcome and HWL's PARKnSHOP are the main players in the Hong Kong retail grocery industry. The two supermarket chains between them accounted for more than 73 percent of the total supermarket turnover in Hong Kong in 2012, according to data provided by consultancy firm Euromonitor.

Hong Kong's retail market scene has also been clouded by the adoption of a mandated minimum wage, and coupled with the possibility of the standard working hour legislation, could raise labor costs for supermarket chains.

Amid the highly developed market and the anticipated rising cost of doing business, it is reasonable for HWL to consider exiting the mature supermarket chain business and moving on to other business assets with high growth potential.

Analysts say the sale of PARKnSHOP could fetch between HK$23.4 billion and HK$31.2 billion, based on the valuation of another supermarket chain, Wellcome, controlled by Dairy Farm International Holdings Ltd, listed in Singapore.

In addition, the proceeds from the PARKnSHOP sale could also provide adequate ammunition for HWL to pursue aggressive overseas business asset acquisitions. If PARKnSHOP can be sold at $4 billion, it will mean that the local supermarket chain can be valued at a multiple of 1.4 times sales, higher than the local-listed Wumart Stores Inc's 1.1 times multiple, but less than Wellcome's 1.65 times multiple, according to Bloomberg data.

Li has already sold many mature business assets to unlock much-needed cash to fund future business growth. In 2011, HWL booked a gain of HK$44.3 billion from packaging its ports assets in the Pearl River Delta region into Hutchison Port Holdings Trust, which is listed in Singapore.

Data compiled by Bloomberg show that the company has announced $4.7 billion of asset acquisitions in the past two years, indicating the conglomerate is ready to snap up more overseas low-priced assets.

"After the economic recession in the last few years, there are many cheap business assets in Europe. Acquiring cheap European business assets is a proven diversification strategy for HWL to expand in those profitable businesses," says Patrick Shum, investment manager of Tengard Fund Management Investment.

"Moreover, the extraordinary gain from the PARKnSHOP sale can help lift the profit level of HWL by giving a one-off gain to the conglomerate."

The ports-to-telecommunications conglomerate has been on a shopping spree in Europe since the start of the global financial crisis of 2008, particularly eyeing European telecommunication and infrastructure assets that can fuel profit growth in the coming years.

HWL in June agreed to buy Telefonica SA's O2, Ireland's second-largest mobile operator, for 850 million euros ($1.1 billion). The conglomerate also held talks with Telecom Italia SpA for a potential merger of their Italian mobile-phone assets.

In January this year, the conglomerate said that its subsidiary Hutchison 3G Austria completed the acquisition of the whole business of Orange Austria from Mid Europa Partners and France Telecom-Orange.

Starting from 2010, HWL has been more aggressive in clinching various overseas infrastructure business assets. In June this year, HWL's listed subsidiary Cheung Kong Infrastructure Holdings Ltd (CKI) acquired a waste-management business in the Netherlands. In January this year, CKI expanded into New Zealand's waste-management business.

In September 2012, CKI acquired a renewable energy power transmission business in Australia. It also held substantial interests in the UK water utility businesses, as it had purchased the UK Wales & West Utilities and Northumbrian Water Group in 2011 and 2012.

"The European infrastructure assets can bestow more stable investment returns to the group in the long run, and that is why HWL is eager to join the bandwagon now," says Dickie Wong, director of Hong Kong-based Kingston Securities Research.

"Selling PARKnSHOP at a good price might be a quick way to cash-in, rather than listing the chain," Wong says. "This is because mainland-based supermarket operators may bid for PARKnSHOP supermarket chain at a higher price than HWL expects, in order to enter the Hong Kong grocery retail market."

The exit from the Hong Kong grocery retail business can also help HWL focus more on its health and beauty retail operations, which have a bigger global footprint and offer higher margins compared with the supermarket business. HWL also operates beauty and healthcare chain Watsons, which includes more than 2,200 stores and over 900 pharmacies.