Zhong Ao Home Group:Core business and M&A in line

1Q16 core result in line and O2O loss persists. 1Q16 net revenue grew38% YoY to Rmb129m vs our 1H16 estimate of Rmb275m. 1Q16 net profitwas Rmb1m, down from Rmb14m a year ago due to higher admin expensesand O2O investments. Adding back O2O loss and share-basedcompensation, 1Q16 adjusted net profit for the core business was Rmb20m,up 30% YoY and on track to our 1H16 estimate of Rmb44m.

Reasonable visibility in M&A pipeline. Thus far, Zhong Ao announced threeM&A deals with a total of 22m sqm GFA, on track to our estimate for FY16 ofa 25m sqm addition from M&A. The Zhejiang acquisition announced March2016 is the largest thus far with 19m sqm GFA alone, but may not completeuntil late 3Q16. We remain positive on the industry consolidation theme andbelieve that leading players with abundant capital can grow throughacquisitions. Valuation of targets has also become more sensible with ZhongAo’s latest Beijing acquisition priced at 6x FY15 PE, partly due to a softerstock market and lower valuation of leading listed players.

O2O loss picking up. O2O’s operating loss was Rmb12m in 1Q16 vs ourRmb22-23m estimate for 1H16. Selling expenses surged 191% to Rmb7m asO2O expanded to five new cities incl. Guangzhou, Foshan, Suzhou, Shaoxingand Ningbo. Given higher selling expenses and sales rebates to first-timebuyers, we deepen our O2O FY16 loss estimate to Rmb57m from Rmb46m.

Tapping into external capital is vital to its O2O platform. The recent news ofissuance of convertible notes to VKC is the right move, in our view.

Cut FY16 net profit by 23% to reflect higher O2O investment, or just a 4%earnings reduction if we exclude the O2O loss. Lower SOTP-based TP toHK$2.05 from HK$2.18.