Event:

It was reported on http://thepaper.cn/ on 3 Jul 2014 that Shanghai planned to hold SOE reform conference around Jul 7 2014 with top officials of Shanghai Municipality likely to attend, at which the Guidance on Mixed Ownership Reform by Shanghai SOE is expected to be rolled out officially.

Comments:

Mixed ownership is the direction for this round of SOE reforms. The Standing Committee of Shanghai Municipal Committee of the CPC Central Committee and Shanghai Municipal Government made clear in the work highlights for 2014: efforts will be made to step up open market restructuring for SOEs, accelerate reform of competitive enterprise ownership diversification, and support more state-owned ownership and other types of ownership to develop into mixed ownership economy. In Mar, the Thematic Panel of the State-owned Assets Supervision and Administration Commission of Shanghai Municipal Government launched relevant work, and on the basis of research, matched with the guiding opinions being drafted by the SASAC of the State Council, and formed the Several Opinions on Promoting Shanghai-based State-owned Enterprises to Actively Develop Mixed Ownership Economy (Tentative) after soliciting opinions from enterprises and state-owned assets administrations in counties and districts. On 13 Jun, Han Zheng, party chief of Shanghai, chaired a meeting of the Standing Committee of Shanghai Municipal Committee, which deliberated and adopted in principle the Several Opinions.

The forerunner among SOEs in Shanghai to undergo reforms. The Company has announced its plan for acquiring a 100% stake in Beijing Shenan Investment Group in cash plus share, and the restructuring will lead to the incorporation of a mixed ownership company in which INESA Electron (600602) (state-owned capital)/Shenan (private capital) will hold a 22%/19% stake, respectively, and the Company’s executives ~contributed Rmb10mn to subscribe to shares to be issued under the private placement. The state-owned asset will remain the largest shareholder upon further purchase, and private capital and its executives will be fully motivated. This scheme is proper, fully-fledged, and highly feasible.

With notable synergy, “new Feilo” will enter a robust growth track. Upon restructuring, the Company’s three major businesses are expected to enter a robust growth track: (i): engineering business: relying on the Company’s platform, its engineering business will gain access to strategic advantage in Shanghai’s lighting engineering market, and fully benefit from the exponential growth of LED lighting transformation market; (2) Yaming manufacturing business: thanks to contribution from engineering projects and corporate efficiency improvement, turnover and net margin are expected to move onto an acceleration track with huge potential for improvement; and (iii) Sunlight Auto is expected to gain funding and resource support from “new Feilo” to give play to its product/customer advantages, thereby entering a faster growth track. Boasting best resources and efficiency, the Company is expected to emerge as the yardstick for SOE reform. As a fair shareholding ratio between state-owned assets and private capital has been set for this restructuring, the advantage of state-owned asset resources and private capital efficiency will come into play simultaneously, and the business per se generates synergy of “manufacturing and engineering”. Therefore, “new Feilo” is expected to enter a track for robust growth in turnover and profit, and become larger and stronger, thereby emerging as the yardstick among peers in Shanghai for SOE reform.

Potential risks: progress of restructuring misses expectation, and efficiency of Yaming Lightingimproves more slowly than expected.

Reiterate BUY rating. We reiterate the Company’s 2014-2016E EPS of Rmb0.14/0.22/0.33 and the pro forma 2014-16E EPS of Rmb0.22/0.33/0.46 (with full-year earnings of Shenan consolidated into its statements and based on diluted share capital after the private placement). Reiterate its target price of Rmb10.56 and BUY rating.