Korean Apple proxy comes to market

Cowell, the camera module manufacturer hopes its listing will benefit from the strong share price momentum driving Apple and its Asian component suppliers.

Korean camera module manufacturer and Apple supplier, Cowell Holdings, has entered a second week of pre-marketing for a $150 million to $200 million initial public offering in Hong Kong. 

Formal book building for the IPO is likely to begin on March 16 when the price range is expected to be set. The deal will comprise a mix of primary and secondary shares with a likely freefloat of 25% of the company's total share capital. 

The deal is likely to be promoted as a cheap proxy for Apple, with the added long-term potential for significant valuation expansion thanks to an undisclosed component the company is developing for the tech giant. Apple is notorious for the incredibly tight confidentiality agreements it imposes on its suppliers and in typical fashion is said to have been "all over" Cowell's prospectus to make sure they have not been compromised.

The secrecy behind the system-in-package (SIP) component Cowell has been developing possibly explains the wide discrepancy between the fair value assumptions syndicate banks have assigned the company. Sole sponsor Morgan Stanley has taken the most conservative approach with a price-earnings range spanning seven to 10 times forecast 2015 earnings of $67 million.

By contrast, joint bookrunner CIMB has assigned a fair value of $663 million to $1.179 billion, equating to a 2015 p/e ratio of nine to 16 times forecast earnings of $73.7 million. 

Morgan Stanley's rolse as sole sponsor is no great surprise given that the former chief investment officer of its private equity arm, Scott Hahn, owns 50% of the company through his private equity fund Hahn & Co. BNP Paribas and CIMB are joint bookrunners.

Korean founder Kwak Joung-Hwan owns the remaining 50% of the PRC-headquartered company he originally listed on the Kosdaq in 2008, only to de-list it three years later. However, a Hong Kong listing makes sense given that the company's operations are in nearby Guangdong Province, Kwak Joung-Hwan resides in mainland China, the company has a Hong Kong registered office and its main client is American. 

Cheap Apple proxy

At the top end of Morgan Stanley's valuation range, Cowell will still be pitched at a generous discount to Apple, which is currently trading at 14.7 times 2015 earnings based on Bloomberg consensus figures. 

Investors will need to decide how strongly they believe the world's biggest company by market capitalisation can maintain its current sales trajectory. They will also need to take a view on how successfully Cowell can execute plans to expand its product portfolio for it.

In 2014, the company derived 77.7% of its revenues from Apple. Morgan Stanley is forecasting that overall sales will jump from $1.037 billion in 2015 to $1.296 billion in 2016 and then $1.719 billion in 2017 when earnings from the new SIP component are expected to really start kicking in.

However, the US bank has taken a more cautious view on how efficiently this sales growth will drop through to the bottom line, forecasting an increase in net profits to $78 million in 2016 and $101 million in 2017. 

Cowell's dependence on Apple clearly constitutes concentration risk, but the company is likely to argue this is more than mitigated by its design work since it effectively binds the two together. As one industry expert commented, "This isn't just a company that manufactures a product and then hopes to sell it. Cowell is building to specifications it has developed by working very closely with Apple."

The company's other big selling point is the pure exposure it offers investors interested in the camera module sector since its main competitors are all diversified into other components. In 2014, Cowell derived 98.6% of its revenues from camera modules and only 1.4% from optical components. 

Analysts currently favour the camera module sector of the smartphone market over casings and other components because handset manufacturers are increasingly relying on camera phones as the key factor to differentiate their products.

Cowell has been an Apple supplier since 2009 and in 2012 started providing flip-chip technology for its camera modules. These chips are far slimmer than the traditional chip-on-board (COB) technology and more complex to produce, resulting in higher average selling prices (ASPs). 

This side of the business has ramped up quickly and now comprises 70% of the camera module revenues that it earned in 2014. COB accounts for the remaining 30%. 

Apples suppliers riding high

Apple's other big supplier is LG Innotek, the world's largest camera module manufacturer with a 14% market share in 2013 compared with Cowell's 5%.  

LG Innotek is currently trading at 12 times forward earnings, making it one of the lowest-rated in its group of comparables. However, the company has been on an upswing since early November, with its share price rising 34.3% since then. 

Samsung Electro-Mechanics (Semco), the world's second-largest manufacturer of camera modules, has also seen its shares perform strongly, rising 84.6% since early October. It had a 12.1% market share in 2013 and is now trading on the highest valuation in the sector at 35 times forward earnings.

The company is expected to be the chief beneficiary of Samsung's new Galaxy S6 phone due to launch this spring as it is the chief supplier for the back-end camera, which typically has far higher megapixels (MP) than the front end camera. Samsung recently announced that it would not be upgrading it from 16MP to 20MP, but will include an optical image sensor, which compensates for camera shake. 

Semco derives 50% of its revenues from the Samsung group but in a recent research report UBS highlighted the progress the company has also made penetrating the Chinese market after becoming a supplier to Xiaomi. 

The other major beneficiary of the new S6 phone is expected to be Partron, which is also listed in South Korea and is the world's fourth largest manufacturer. It will be the major supplier for the front-end camera.

Partron's share price has almost doubled since early October when it traded at Won7,700. At Tuesday's close it was bid at Won14,050, equating to a forward price-earnings ratio of 10 times earnings. 

The other two main comparables for Cowell are Hong Kong-listed Sunny Optical and AAC Technology. The former is currently trading at 15 times forward earnings and, until recently, was trading at a premium to its Korean peers because clients such as Xiaomi were gaining market share very quickly. 

Shares in AAC Technology, which are trading at 20 times forecast 2015 earnings, have gained almost 30% since December. 

Valuation premium

In the syndicate research, analysts argue that Cowell will trade up to a valuation premium because it has a better earnings outlook than its competitors and also improving margins thanks to its design edge. Yet component suppliers typically report very thin margins and Cowell is no different, with a net margin of 6% in 2014. 

This is, however, higher than LG Innotek's estimated 2014 net margin of 1.7%. 

Analysts say that despite a 2.1% volume decline in 2014, Cowell was able to increase its ASP by 11.3% year-on-year to $4.52. 

However, Cowell's recent earnings have been volatile, with net profit increasing by 281% in 2013 before recording a far more modest 6% increase in 2014. The lower 2014 figure has been attributed to a partial shutdown after the company upgraded its facilities and increased costs from rising head count in its research and development division. 

CIMB forecasts that Cowell's net profit will increase by a compound annual growth rate of 25% between 2014 and 2017, while net margins will expand by 1.2%. 

It says the company will benefit from Apple's short product cycles and the trend for increasing megapixels, which command higher ASPs. 

International Business Strategies forecasts the camera module market will jump from $16.4 billion in 2013 to $34.4 billion by 2020. It also believes that the strongest subset will be 16MP camera modules, which will grow by 49% between 2013 and 2020.  


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