This article first appeared in The Edge Financial Daily on October 16, 2017 - October 22, 2017

KUALA LUMPUR: When Hovid Bhd’s two manufacturing licences were revoked by the pharmaceutical services division of the health ministry on Jan 9 over compliance issues, some investors panicked, dumping their shares even at a low of 24 sen on the next day after the announcement.

The stock on Jan 10 opened at 25 sen — a sharp discount to the previous day’s closing of 34.5 sen, evident of irrational panic selling.

Hovid’s two production licences were reinstated in March and May separately. Subsequently, its share price regained most lost ground.

Against such a background, its controlling shareholder David Ho Sue San found an interested party, Fajar Astoria Sdn Bhd, a private equity firm, to partner with him for a privatisation exercise. Last week, Ho together with Fajar Astoria made a voluntary takeover offer of 38 sen per share and 20 sen per warrant to buy all the shares not owned by them in the pharmaceutical company.

Upon successful completion of the offer, Ho intends to consolidate his interest in the shares and warrants in the name of Fajar Astoria in exchange for a proportionate shareholding in either Fajar Astoria or its holding company, TAEL Astoria Investments Ltd. Currently, Ho holds a 33.72% stake in Hovid, while the partners acting in concert with him, including his wife East Jacqueline Judith and his siblings, have a collective 0.34% stake in the company.

The price is 10% higher than the last trading price before the suspension of its two manufacturing licences. According to its announcement to Bursa Malaysia, the offer price represents an 18.87% premium to its one-year volume weighted average price of 32 sen.

Now, for minority shareholders who were unfazed by the suspension of production in January and have held onto their shares, should they take up the takeover offer to exit at this point of time?

For the financial year ended June 30, 2017 (FY17), Hovid reported a net loss of RM1.53 million, from a net profit of RM17.9 million in FY16. Revenue for FY17 came in 10% lower at RM169.93 million from RM189.03 million in FY16.

The net loss showed that the suspension of the two manufacturing licences made a big dent in Hovid’s earnings — something that management had forewarned earlier. Hovid also encountered labour shortage problems that resulted in a low capacity utilisation rate of about 70%.

CIMB Research, in its quarterly review on Sept 4, cut its earnings forecasts for FY18 and FY19 to account for lower production volume and further delays in Hovid’s Chemor plant extension. CIMB anticipated RM14.6 million, or 1.7 sen per share for FY18. Based on last Friday’s closing price of 36 sen, Hovid shares are trading at a forward 12-month price-earnings ratio (PER) of 21.18 times, which is relatively higher than its peers. Pharmaniaga Bhd is trading at a forward PER of 17.66 times and YSP Southeast Asia Holding Bhd 15.53 times.

Looking at peer comparisons, the takeover offer seems worth considering based on the earnings forecast of 1.7 sen. But it may be worth noting that the company posted earnings per share of 2.24 sen for FY16.

There is a wild card that minority shareholders should not neglect — the new capacity which has been delayed. The extension of capacity is expected to come on stream by year end, according to a fund manager.

According to CIMB, the Chemor plant extension could raise Hovid’s existing tablet and capsule capacity by 70% (from the original capacity). But this will happen gradually.

The new capacity will translate into stronger earnings growth in future for Hovid when things are falling in place. This may be why Fajar Astoria is keen on pouring in money to take Hovid private — a deal that will cost them about RM243.1 million.

Hovid’s production facilities include the 20-acre (8.09ha) Chemor plant with softgel packing, effervescent dosage and oral solid dosage facilities, while its three-acre Ipoh plant, where its headquarters are in, produces softgel encapsulation, oral liquid, penicillin products and its heritage Ho Yan Hor herbal tea.

Aside from the manufacturing plants, Hovid has a research and development centre in Penang which is dedicated to bioequivalence studies.

With a market capitalisation of RM295 million, which is less than US$85 million, Hovid does appear to be an attractive merger and acquisition (M&A) target for foreign pharmaceutical giants that are looking for capacity expansion in this part of the world. In fact, CIMB said that it would turn more positive on Hovid upon a stronger-than-expected recovery in sales volume and earlier delivery of the extension of its Chemor plant.

Will minority shareholders wait further for the new capacity to ride on the earnings growth or cash out now at 38 sen per share?