15 February 2008Market Daily5715 February 2008 Asia Pacific/New Zealand Equity Research Electronic Equipment and Instruments (Information Technology OVERWEIGHT) Rakon (RAK.NZ) Rating (from Outperform) NEUTRAL* Price (14 Feb 08) 2.90 (NZ$) Target price (12M) (from 4.35) 3.50 (NZ$) Market cap: 371 (NZ$m) Projected return: 0 Capital gain (%) 20.7% Gross yield (%) 0% Total return (%) 20.7% Excess return** (%) -10.7% 52-week price range (NZ$) 2.90-5.67 * Stock ratings are relative to the relevant country index** Relative to market. (see disclosure appendix for fulldescription of CSEA rating system. RATING CHANGE/TARGET PRICE CHANGEIndian JV and a nice little downgrade ■Event: RAK yesterday announced that it was entering into a JV with Indian owned and based Centum Electronics Limited (‘Centum’). RAK has a 49% share of the JV which is due to settle at the end of March and is based in Bangalore, India.■The company also downgraded its earnings guidance for FY08 from the lower end of NZ$27–32mn to NZ$23mn–$24mn for EBITDA. The reasons for the downgrade were currency, continued European underperformance and sales being deferred in the second half by the NZ business. ■View: We view the JV as a positive step in alleviating some of the issues experienced with the French operations acquired from C-Mac 12 months ago. We understand it i s likely to result in a positive contribution to EBITDA of NZ$3mn by the end of calendar 2008.■The downgrade announced by Rakon, and in particular, the significantly lower expectation for revenue (due to slower growth than we had forecast, higher ASP decline and some impact from currency), is disappointing. We have as a result reviewed the significant growth we had in both revenue and earnings in FY09 and FY10 and reduced these as a result. We now forecast EBITDA of NZ$35.4mn in FY09 (previously NZ$50.0mn) and NZ$56.5mn in FY10 (previously NZ$71.8mn). ■Outlook: We continue to believe the outlook for Rakon remains positive in regard to the continued growth of the GPS market. However, we have become more cautious regarding that growth and also around the margins RAK is going to be able to earn with continued ASP declines. ■Valuation: After incorporating our revised forecasts our DCF valuation has fallen from NZ$3.82 to NZ$3.14. We have also reduced our 12-month target price accordingly to NZ$3.50 from NZ$4.35 and this now leads to a NEUTRAL rating (previously OUTPERFORM). Share price performance 2.50 3.30 4.10 4.90 5.70 Feb- 07 Mar- 07 Apr-07 May-07 Jun- 07 Jul-07 Aug- 07 Sep-07 Oct-07 Nov-07 Dec-07 Jan-08 Feb-08 50 70 90 110 130 Rakon L im it ed (LHS) Relative to NZSXALL The price relative chart measures performance against the NZX50 index which closed at 3548 on 14 Feb 08On 14 Feb 08, the spot exchange rate was NZ$1.28/US$1 Performance 1M 3M 12M Absolute(%) -22.7% -44.4% -38.2% Rel-NZX50(%) -15.5% -30.1% -23.1% Financial and valuation metrics -2 Year to Mar 31 2006A 2007A 2008F 2009F 2010F NPAT adj NZ$m 4.8 10.4 11.0 19.9 35.7 EPSadj NZc 4.7 8.4 9.5 15.3 27.5 EPS Growth % -99.6 76.4 13.1 61.9 79.1 P/E X 61.1 34.6 30.6 18.9 10.6 CPS NZc 7.7 10.8 14.0 20.2 32.7 P/CF X 37.8 26.9 20.7 14.4 8.9 EV/EBITDA X 32.3 18.7 15.3 10.0 5.7 Dividend NZc 0.0 0.0 0.0 0.0 0.0 Imputation % 0 0 0 0 0 Net Yield % 0.0 0.0 0.0 0.0 0.0 Gross Yield % 0.0 0.0 0.0 0.0 0.0 Source: Company data, NZX, First NZ Capital estimates
Electronic Equipment and Instruments (Information Technology OVERWEIGHT)
Rakon
(RAK.NZ)
Rating (from Outperform) NEUTRAL*Price (14 Feb 08) 2.90 (NZ$)Target price (12M) (from 4.35) 3.50 (NZ$)Market cap: 371 (NZ$m)Projected return: 0Capital gain (%) 20.7%Gross yield (%) 0%Total return (%) 20.7%Excess return** (%) -10.7%52-week price range (NZ$) 2.90-5.67* Stock ratings are relative to the relevant country index
** Relative to market. (see disclosure appendix for full
description of CSEA rating system.
RATING CHANGE/TARGET PRICE CHANGE
Indian JV and a nice little downgrade
■ Event: RAK yesterday announced that it was entering into a JV with Indianowned and based Centum Electronics Limited (‘Centum’). RAK has a 49%
share of the JV which is due to settle at the end of March and is based inBangalore, India.
■ The company also downgraded its earnings guidance for FY08 from thelower end of NZ$27–32mn to NZ$23mn–$24mn for EBITDA. The reasonsfor the downgrade were currency, continued European underperformanceand sales being deferred in the second half by the NZ business.
■ View: We view the JV as a positive step in alleviating some of the issuesexperienced with the French operations acquired from C-Mac 12 monthsago. We understand it is likely to result in a positive contribution to EBITDAof NZ$3mn by the end of calendar 2008.
■ The downgrade announced by Rakon, and in particular, the significantlylower expectation for revenue (due to slower growth than we had forecast,higher ASP decline and some impact from currency), is disappointing. We
have as a result reviewed the significant growth we had in both revenue andearnings in FY09 and FY10 and reduced these as a result. We now forecastEBITDA of NZ$35.4mn in FY09 (previously NZ$50.0mn) and NZ$56.5mn inFY10 (previously NZ$71.8mn).
■ Outlook: We continue to believe the outlook for Rakon remains positive inregard to the continued growth of the GPS market. However, we havebecome more cautious regarding that growth and also around the marginsRAK is going to be able to earn with continued ASP declines.
■ Valuation: After incorporating our revised forecasts our DCF valuation has
fallen from NZ$3.82 to NZ$3.14. We have also reduced our 12-month target
price accordingly to NZ$3.50 from NZ$4.35 and this now leads to a
Figure 1: Rakon Financial Summary PROFIT & LOSS ($m) BALANCE SHEET ($m) Ye ar to 31 M ar 2006A 2007A 2008F 2009F 2010F Year to 31 M ar 2006A 2007A 2008F 2009F 2010F
Indian JV and a nice little downgradeJoint Venture
RAK yesterday announced that it was entering into a JV with Indian-owned and based
Centum Electronics Limited (‘Centum’) to manufacture selected Rakon products alongside
Centum’s Frequency Control Products (FCP) in Bangalore, India. The JV has the Bombay
Stock Exchange listed Centum holding a 51% share and Rakon a 49% share. The new
company will combine Centum’s existing design and manufacturing capability for
frequency control products with some of Rakon’s OCXO design and manufacturing
expertise, which were developed and are currently undertaken in France.
The two companies have entered into an agreement protecting the IP rights of both
companies, with Rakon having exclusive rights to sell outside of India all products
manufactured by the JV, and Centum with similar exclusive rights within India.
The JV is due to settle at the end of March with Rakon transferring in its operations from
France over the following six months.
Who is Centum?
Centum Electronics manufactures components and provides manufacturing services to
customers in Europe and South Asia. The company’s component operations design and
manufacture frequency control products for telecom companies, and hybrid microcircuits
used in aerospace and military applications, power products, telecom equipment,
automotive systems, and medical electronics. It also provides electronics manufacturing
and software engineering services.
The company employs 350 staff (with approximately 100 to be transferred to the JV) and
was recently recognised as one of the 500 most valuable companies in India Founded in
1993. Centum is listed on the Bombay Stock Exchange (BSE) and National Stock
Exchange (NSE). Key facts include (from the Centum websitehttp://www.solectroncentum.com/ ).
■ Largest design, manufacturing and exporting company for frequency control products
in India.
■ Exporting to the most discerning telecom companies in the world like Nortel, Lucent,
Nokia, Marconi.
■ Hi-rel products conforming to the most stringent MIL and aerospace requirements
(MIL-O-55310).
■ Products approved by C-DOT and CACT for telecom applications.
■ Approval from Regional Centre for Military Airworthiness for usage in military and
aerospace applications.
Impact for Rakon
We view the JV as a positive step in alleviating some of the issues experienced with theFrench operations acquired from C-Mac 12 months ago. The JV is also likely to provideRakon with the potential to upscale production of its OCXO products as demand continuesto grow from the telecommunications market.
We understand once the JV is fully operational, expected late in 2008, Rakon’s annualEBITDA is anticipated to improve by approximately NZ$3mn. This is as a result of theimproved cost structure and contribution from the former Centum business.
After transaction costs, Rakon is also anticipated to book a one-off gain on the transaction
of approximately NZ$1mn, reflecting the realisation of the gain over book value of assets
transferred to the JV. We understand the JV enables Rakon to eliminate reliance on
temporary staff which were employed in France to meet the sudden increase in demand
soon after Rakon acquired the business in March 2007.
The JV is to be equity accounted in the RAK accounts once it is operational. At this stage
we have only incorporated the anticipated cost savings in our EBITDA forecast for FY10
and not the estimated full effects from the JV. We anticipate doing that once further
information becomes available, however, we do not anticipate it will have a significant
impact on either our earnings estimates or valuation as we see the EBITDA savings ashaving the largest impact.
Update on FY08 guidanceRakon also provided an update on its forecast results for the year ending 31 March 2008.
The company downgraded its earnings guidance for FY08 from the lower end of NZ$27–
$32mn to NZ$23mn–$24mn for EBITDA. The reasons for the downgrade were currency,
continued European underperformance and sales being deferred in the second half by the
NZ business.
Revenue growth for the FY08 in USD terms for the traditional New Zealand business is
now estimated to be up 24% (after being up 32% in the first half), with volumes up 48%
(after being up 53% in the first half), implying an average selling price decline of
approximately 16%. This led to overall revenue being forecast to be NZ$175mn, we had
previously forecast NZ$197.7mn after the company earned NZ$89.9mn in the first half.
While it is clear the company has continued to be impacted by the weak USD at the
revenue line, it is also clear that volume growth is behind that expected and that
experienced in the first half. The company also commented that a small amount of sales
had been deferred from the second half.
The company now anticipates FY08 EBITDA margin to be approximately 13%, significantly
below the 19.1% experienced in FY07 and slightly below the 13.8% in the first half. The
reasons given for the decline in margin (and therefore guidance) were currency (NZ$3mn),
the European operations (NZ$1mn) and the second-half sales deferred in NZ (NZ$1mn).
Outlook comments
The outlook appears to continue to remain positive for the coming calendar year despite
the impact of financial market turmoil and its expected impact on consumer demand. Thecompany commented that it was cautious on the impact of the credit situation on its
business, however, its customers that are exposed to consumer demand have been
affirming strong forecasts for the next 12 months.
The company commented that even with the NZ dollar remaining within its current range, it
is confident that fiscal 2009 should produce a result appreciably better than it expects for
fiscal 2008. It anticipates EBITDA margins to improve from 13% in FY08 to at least 18%
within the next 24 months.
The company also commented that it continued to make progress on its options in China
and anticipates that manufacturing in China is likely to commence within the next 18
months. We understand the company is currently looking at sites in Shinjin with a view
towards locating the manufacturing facility there.
Review of forecasts
The downgrade announced by Rakon, and in particular the significantly lower expectation
for revenue (due to slower growth than we had forecast, higher ASP decline and some
impact from currency), is disappointing. We have as a result reviewed the significant
growth we had in both revenue and earnings in FY09 and FY10 and reduced these as a
result. We now forecast EBITDA of NZ$35.4mn in FY09 (previously NZ$50.0mn) and
NZ$56.5mn in FY10 (previously NZ$71.8mn). We have also reflected the revised
guidance in our forecasts and now forecast NZ$23.8mn EBITDA (which is at the top of the
revised guidance range provided by the company) and NZ$11.6mn NPAT in FY08 (which
included the NZ$1.0mn abnormal gain relating to the sale of assets to the JV).
We have also incorporated into our forecasts new currency assumptions which have been
updated for the actual currency track since they were last published in November.
