Company Update, 17 February 2015
Sound Global (967 HK)
Buy (Maintained)
Industrial - Environment Control
Market Cap: USD1,472m
Target Price:
Price:
HKD12.00
HKD7.58
Macro
Risks
Convincing Rebuttal Of Allegations
Growth
Value
Sound Global (967 HK)
Relative to Hang Seng Index (RHS)
9.60
123
9.10
117
8.60
111
92
6.60
86
6.10
79
5.60
20
18
16
14
12
10
8
6
4
2
73
Aug-14
Dec-14
7.10
Oct-14
98
Jun-14
104
7.60
Apr-14
8.10
Feb-14
Vol m
Price Close


30.2m/3.90m
Cons. Upside (%)
42.5
Upside (%)
58.3
52-wk Price low/high (HKD)

5.92 - 9.12
Free float (%)
31
Share outstanding (m)
1,506
Shareholders (%)
Wen Yibo
50.3
China Construction Bank
11.2
International Finance Corp
7.7
Share Performance (%)
YTD
1m
3m
6m
12m
Absolute
(15.6)
(8.6)
(14.7)
(1.6)
(0.3)
Relative
(20.2)
(10.5)
(17.5)
(0.8)
(11.7)

Emerson Analytic's (Emerson) key allegations. They were: i) the
CNY1bn revenue of a wholly-owned subsidiary of Beijing Epure
International Water (Epure) was fictitious as Emerson could not find
enough of Epure's projects on the internet, ii) that the Anshan projects
were completed in 2012 but looked like they were booked again in 2013,
iii) the interest income rate was too low (<0.5%) – implying an overstated
cash balance, iv) revenue from the CNY141m Jingzhou Jingqing project
was booked in 2008 but Sound Environmental (000826 CH, NR) – the
project’s client – only obtained shareholders’ approval only in Jan 2009.
For details on the allegations, Sound Global’s (SGL) explanations and
our comments, please see pages 2-4.
Share price stabilising plan. SGL plans to repurchase its shares, with
the maximum allowed at 10% of the outstanding shares. Its chairman
also intends to increase his stake in the company, up to a maximum
stake of 75% if necessary, although a concrete timetable is unavailable.
Improving transparency on external engineering, procurement and
construction (EPC) works. In the future, SGL intends to make
announcements on external EPC won via public tendering. For projects
secured via negotiations, it plans to report quarterly on the aggregate
external EPC works secured by region, type (water supply or sewage
treatment) and number of projects.
Maintain BUY and HKD12.00 TP. Our DCF-based TP of HKD12.00
implies a FY15F P/E of 19x. The stock is now trading at a FY15F P/E of
13x, slightly above the HK-listed waste water sector average of 18x. We
expect SGL to deliver a 3-year recurring EPS CAGR of approximately
26%, which is a tad ahead of the HK-listed sector’s 22%. Note that the
company’s capacity expansion has accelerated since its financial
bottleneck was resolved in 4Q13 via the issue of offshore loans.
Forecasts and Valuations
Shariah compliant
Laurent Wong +852 2103 9432
laurent.wong@rhbgroup.com
Dec-12
Dec-13
2,652
3,140
3,868
5,046
6,039
Reported net profit (CNYm)
428
423
575
820
1,188
Recurring net profit (CNYm)
430
432
575
820
1,188
Recurring net profit growth (%)
1.6
0.4
33.0
42.6
44.9
Recurring EPS (CNY)
0.33
0.33
0.40
0.50
0.67
Recurring P/E (x)
18.3
18.2
15.2
12.2
9.1
P/B (x)
2.98
2.56
2.09
1.55
1.33
Total turnover (CNYm)
P/CF (x)
na
na
Dec-14F Dec-15F Dec-16F
na
na
194
EV/EBITDA (x)
11.3
9.2
9.7
9.5
8.3
Return on average equity (%)
17.3
14.8
15.5
14.4
15.7
3.6
36.5
62.7
66.6
3.7
(0.4)
0.3
Net debt to equity (%)
Our vs consensus EPS (adjusted) (%)
See important disclosures at the end of this report


3

.
2
0
.
2
0
0
.2
0
0
SGL has issued a detailed rebuttal to Emerson’s allegations of 4 and 15 .
0
Feb 2015. Despite short-term share price pressure, we keep our BUY 0
call and DCF-based HKD12.00 TP (58.3% upside). We find its 0
explanations convincing and consistent with our expectations. During
the conference call, SGL promised to improve transparency on external
EPC projects. Its chairman is also ready to increase his stake and SGL
also intends to repurchase its shares.
Source: Bloomberg
Avg Turnover (HKD/USD)




Source: Company data, RHB
net cash
Powered by EFA
TM
Platform
1
Sound Global
(967 HK)
17 February 2015
Emerson’s 4 Feb key allegations, SGL's responses and our comments
Emerson: According to the approval report by China Regal Assets Appraisal Co Ltd
(CR Appraisal), the CNY1bn technology services revenue (inside the external EPC
segment) was fictitious, generated by a wholly-owned subsidiary of Epure, which was
not commonly known by staff. "Technology services revenue” was never reported
separately in SGL’s annual report. Additionally, Epure’s 2012 revenue filed to the
State Administration of Industry and Commerce (SAIC) was 24% lower than the
number shown in CR Appraisal’s report. Lastly, Epure failed to pay the social security
payment (CNY210,000) on time in Nov 2011, suggesting that its cash balance was
overstated.
SGL:

Most of SGL’s EPC projects were secured by negotiation, not by bidding.
The company is generally not allowed to disclose the details (including the
owners) of the projects. Hence, this explains why Emerson was unable to
use an internet search (eg dowater.com) to get the full EPC projects list in
China.

CR Appraisal confirmed to have erroneously classified all of Epure’s
revenue as “technology services revenue”, but it should only be 4% in 2013
based on International Financial Reporting Standards (IFRS). The remaining
96% should be booked as “construction services revenue”. For financial
reporting, SGL normally groups the two under “turnkey projects and services
revenue”.

Epure’s revenue in 2012, which was filed with the SAIC, was 24% lower
than that in CR Appraisal report. The accounts that Epure filed with the
SAIC were based on Chinese Generally Accepted Accounting Principles
(GAAP) and audited by Beijing Zhongpingjian Huahao CPA (Zhongpingjian).
In 2012, for some of the EPC projects where Epure acted as the main EPC
contractor, the sub-contractors directly issued invoices to the project owners,
and Zhongpingjian excluded them from Epure’s revenue. However, these
sub-contracted constructions were part of the EPC contract signed with the
project owners, and so SGL booked revenue based on the percentage of
completion.

Epure’s revenue has been audited by Deloitte with an unqualified opinion.

Epure obtained environmental engineering (water pollution control) design
qualification certificate (Class B) in Feb 2009 and certificate (Class A)
licences in Dec 2010.

The late payment (Nov 2011) of social insurance by Epure was due to a
clerical error and that the company had settled this payment in Dec 2011.
Epure had CNY1,299m cash on hand in Dec 2013, as audited by Deloitte.
Our comments:
We believe the strongest evidence that suggests the authenticity of the CNY1bn
technology revenue each year in 2011-2013 lies with the filing with the SAIC. If such
a figure was faked or overstated, the sum filed would be much lower, and a company
undertaking this would have been able to pay less tax.
Although SGL did not give the full list of its external EPC projects to uphold
confidentiality, it has revealed three external EPC projects (investments totalling:
CNY550m) to the Anshan Environmental Protection Bureau (Anshan Bureau). These
projects were unknown to Emerson. This is a solid piece of evidence that proves that
the latter was not able to get the full list of water EPC projects in China via internet
research. Hence, its accusations on both Anshan projects (see point 2) and Epure’s
CNY1bn revenue is unfounded.
SGL explained most of Epure’s revenue should be “construction service revenue”
and “technology services revenue” (ie design revenue), which accounted for only 4%
of the latter’s income in 2013. Thus, SGL did not report “technology services
revenue” separately.
Epure’s 2012 revenue filed with the SAIC was 24% lower than the amount in the CR
Appraisal report. We agree that accounting revenue booking should be based on
signed EPC contracts and the percentage of completion. In contrast, for SAIC’s filing,
revenue is based on invoices, ie if SGL's subcontractors send invoices directly to the
project owners, SGL will bill the profit margins to the project owners.
At only CNY210,000, the late payment was a very small amount. Furthermore, it was
settled quickly.
See important disclosures at the end of this report
2
Sound Global
(967 HK)
17 February 2015
Emerson: The Anshan projects – three build, operate and transfer (BOT) projects
with a total capacity of 210,000 tonnes and total investments of CNY487m – were
completed and booked in 2012. However, they seem to have been booked again in
2013.
SGL: In Dec 2011, SGL secured CNY200m worth of build and transfer (BT)
pipe network and pump station construction works for the three Anshan BOT
projects. It also secured another three external EPC projects (worth CNY550m)
in Anshan via competitive negotiation, namely the: i) Anshan Lishan district
sewage collection pipe network project, ii) Anshan Qianshan district sewage
collection pipe network project, and iii) Anshan Panjialu sewage interception
project. In 2013, SGL booked construction revenue of CNY138m for pipelines
and pump stations, and CNY380m for the three external EPC works. The
remaining construction revenue was for auxiliary works, eg roads and
landscaping, for the three BOT projects.
Our comments: SGL’s clarification is convincing. The three external EPC
projects that were never disclosed before, together with the BT construction of
pipes and pump stations, can sufficiently explain the revenue from the Anshan
Bureau in 2013.
Emerson: Revenue from the CNY141m Jingzhou Jingqing EPC project – Sound
Environmental was the client – was booked in 2008, but the latter only obtained
shareholders’ approval in Jan 2009.
SGL: Sound Environmental signed the BOT agreement and pipe network
construction project contract on 18 Feb 2008 with Jingzhou Municipal
Government, which required immediate construction. Thus, the former started
construction on 23 Feb 2008. Sound Environmental announced this contract on
19 Dec 2008 and obtained its shareholders’ approval on 4 Jan 2009.
Our comments: SGL was able to explain that the Jingzhou revenue was not
fictitious. Nevertheless, the commencement of connection transaction before
obtaining shareholders’ approval was a bad practice and management should
improve its corporate governance in future. The recent restructuring
(announced in Sep 2014) to let Sound Environmental directly hold a 31.2%
stake in SGL will likely eliminate connected transactions going forward.
Emerson: According to Sound Global’s HK listing document published in Jun 2010,
the Guangxi Chongzuo project had 30,000 tonnes daily capacity and its total
investment would be CNY68.2m. SGL recognised CNY56.1m as construction
revenue as of 31 Mar 2010. In fact, Chongzuo Phase 1 (in 2009) had only 15,000
tonnes/day capacity.
SGL: The Chongzuo project had 30,000 tonnes/day short-term capacity and the
planned investment was CNY68.2m. Phase 1 had 15,000 tonnes/day capacity
with CNY59.5m worth of total investment. The building structure (including the
building complex, canteen, pump room and power distribution room) was based
on 30,000 tonnes/day, whereas the sedimentation basin, biochemical treatment
and sewage treatment facilities were constructed based on a capacity of 15,000
tonnes/day. SGL booked CNY56.3m construction revenue in 2008-2010. Phase
2 has a capacity of 15,000 tonnes/day, with an investment of CNY13m.
Our comments: The Chongzuo project had only 15,000 tonnes/day capacity.
However, Phase 1 incurred much higher investment than Phase 2, because
many building structure construction was based on 30,000 tonnes/day capacity.
Thus, the revenue recognition of CNY56.3m is valid.
See important disclosures at the end of this report
3
Sound Global
(967 HK)
17 February 2015
Emerson: The announcement of the Shaanxi Hancheng project in 2012 had misled
investors as a BOT project with a total investment of CNY98m when, in fact, it was
only an external EPC upgrade project with CNY20m worth of investments.
SGL: SGL secured the Hancheng Phase 1 BOT in 2008, which had a capacity
of 25,000 tonnes/day and an investment of CNY47.9m. It booked most of the
construction revenue in 2009-2011. Phase 2 had a capacity of 25,000
tonnes/day with an investment of CNY29.5m. The total investments of both
Phases 1 and 2 were CNY77.4m. In Oct 2012, SGL announced that it had
secured a contract to upgrade Phase 1’s water discharge standard from Class
IB to Class IA 1, and that the investment of the upgrade was CNY20.6m. Thus,
the total investment of the entire Hancheng project has been increased to
CNY97.7m. For the upgrade, CNY13.8m worth of construction revenue was
booked in 2013.
Our comments: The allegation that the Hancheng project was a misleading
announcement is invalid, since the headline of the announcement already
suggested a "wastewater treatment upgrading project". Now, a clearer
breakdown of the CNY98m investment (including investments on the upgrade)
should offer investors greater clarity. We expect better disclosures for future
projects.
Emerson: Interest income rate of less than 0.5% was too low, implying an overstated
cash balance.
SGL: The EPC business requires high liquidity. Keeping adequate cash in hand
can facilitate high quality M&A and ensures that the company does not lose out
to its competition. Additionally, when bidding for EPC projects, SGL is required
to demonstrate strong funding capabilities to win the trust of the project owners.
Thus, SGL can only keep the cash mainly in current accounts. The effective
interest income rate is 0.355%, consistent with annual interest rate, which can
be earned through current account deposits offered by banks in China.
Our comments: SGL’s explanation echoes our expectations that the low
effective interest rate was due to SGL's EPC business requiring cash during the
year. The company often borrows in 2H (eg the USD110m syndicated loan in
Taiwan was raised in 4Q13). Hence, the new cash cannot contribute to a fullyear interest income.
Emerson’s 15 Feb key allegations, SGL's responses and our comments
Emerson: SGL recognised CNY314m in revenue with respect to the three Anshan
BOT projects and CNY61.8m with respect to the pipe network/pump stations
construction in 2012 (a total of CNY376m, or 14.2% of 2012 revenue). However, in its
2012 annual report, the company said its largest customer for that year was the
Jiangyan City Housing and Urban Construction Bureau, which contributed 10.73% to
its revenue. Why not the Anshan Bureau instead?
SGL: The question was answered in the recent conference call with
management. The Anshan BOT projects booked CNY314m in construction
revenue in 2012. In fact, the construction was done for internal BOT projects.
Although the revenue from Anshan was huge, it was not the largest external
client. Hence, SGL attributed the Jiangyan project instead of Anshan as its
largest client in the 2012 Annual Report (page 116).
Our comments: We believe that SGL’s clarification is convincing.
See important disclosures at the end of this report
4
Sound Global
(967 HK)
17 February 2015
Recommendation Chart
Price Close
Recommendations & Target Price
12.0
na
10.00
9.00
8.00
7.00
6.00
5.00
4.00
3.00
Buy
2.00
Oct-10
Neutral
Sell
Trading Buy
Nov-11
Dec-12
Take Prof it
Not Rated
Jan-14
Source: RHB, Bloomberg
Date
Recommendation
Target Price
2014-12-08
Buy
2014-04-15
Not Rated
12.0
na
Price
7.5
7.0
Source: RHB, Bloomberg
See important disclosures at the end of this report
5
RHB Guide to Investment Ratings
Buy: Share price may exceed 10% over the next 12 months
Trading Buy: Share price may exceed 15% over the next 3 months, however longer-term outlook remains uncertain
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Take Profit: Target price has been attained. Look to accumulate at lower levels
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Not Rated: Stock is not within regular research coverage
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