MClean Technologies Berhad FV: RM 0.29 Growth Intact but Pricey Valuations

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1 TA Securities A Member of the TA Group MENARA TA ONE, 22 JALAN P. RAMLEE, KUALA LUMPUR, MALAYSIA TEL: / FAX: NEW LISTING Wednesday, April 27, 2011 FBM KLCI: 1, Sector: Technology MClean Technologies Berhad FV: RM 0.29 Growth Intact but Pricey Valuations THIS REPORT IS STRICTLY FOR INTERNAL CIRCULATION ONLY* ACE Market Listing DO NOT SUBSCRIBE TA Research Team Coverage ext:1641 stchin@ta.com.my MClean Technologies Berhad (MClean) is involved in the micro contamination control services provider for the hard disk drive (HDD) industry. The Group s core businesses are provide cleaning services for the HDD and semi-conductor industries and cleaning room assembly. Precision cleaning is the group s major revenue contributor accounting for 84% of the group s total sales. Plastic injection moulding accounted for the remaining l6%. Its customer base is concentrated in three countries, i.e. Singapore, Malaysia, PRC which cumulatively accounted 96% of the group revenue. Share Information Listing ACEMarket Enlarged Share Capital (mn) Market RM0.52 (mn) 61.0 Par Value (RM) 0.25 Issue Price (RM) 0.52 Oversubscription rate Estimated free float (%) Tentative Listing Date NA NA 10-May-11 We value the stock at 29 sen, based on 7x fair PER. The fair PER is pegged at the industry market cap weighted average PER. While we are positive on the industry outlook, we are concerned over the competitive nature of industry, the low barrier to industry and significant reliance on a single customer (Seagate). Moreover, at 11x 12x PER, we feel valuations are demanding. On the other hand, the effective subscription price to investors after including the intrinsic value of the warrant is only 26 sen. That said, at our fair value of 29 sen for the mother share, the Black Scholes model fair value is only 5 sen and the warrants will be out of the money. Therefore, we recommend investors not to subscribe to the IPO issue. CORPORATE PROFILE MClean Technologies Berhad (MClean) is involved in the micro contamination control services provider for the hard disk drive (HDD) industry. The Group s core businesses are provide cleaning services for the HDD and semi-conductor industries and cleaning room assembly. MClean Technologies Pte Ltd was incorporated on 17 March 2010 as a private limited company under the name of MClean Technologies Berhad and converted into public limited company on 18 October The history of MClean traces back to 2001 when it started with Magnetronics founded by Bert Chow and Mr. Lee Zhi Hong. The company provided cleaning and assembly services to the HDD and semiconductor industries for its customers based in Singapore. Tentative Listing Dates Event Opening of the IPO Closing of the IPO Balloting of Applications Allotment of Shares Listing Ratio & Analysis Tentative Date 21-Apr Apr-11 3-May-11 9-May May-11 NTA per share (post IPO)(sen) 0.20 Price to NTA (x) 2.6 Proforma ROE (%) 25.2 Proforma ROA (%) 20.0 Proforma Net Gearing (x) Net Cash Proforma Current Ratio (x) 3.0 Utilisation of Proceeds RMmn % Capex Working Capital Estimated Listing Expenses TOTAL Page 1 of 12

2 Figure 1: Key milestones Year Key Achievement / Milestones of MClean 2001 Magnetronics founded by Bert Chow and Lee Zhi Hong 2003 MClean Singapore was established 2004 Obtained qualification approval for media cassette washing from: - Seagate STRMO - Hoya Magnetics 2005 Obtained qualification approval from: - Hitachi - Seagate AMK - Western Digital Obtained ISO9001:2000 Certification 2006 Techsin Wuxi was established 2007 Expanded MClean Singapore s production line Qualification approval from Seagate Technology International Wuxi for Techsin Wuxi 2008 Accredited with ISO/TS 16949:2002 for Techsin Wuxi Qualification approval from Seagate STMicroelectronics 2009 Obtained ISO9001:2000 Certification for Techsin Wuxi Qualification approval from Seagate STRMO and STMicroelectronics 2010 Facility qualification from Seagate for Techsin Wuxi Qualification approval from Hereaus Material Technology Singapore IPO STATISTICS New Shares : 15.4mn Offer for sale : 11.1mn Enlarged issued and full paid-up capital : 117.4mn Market Cap based on IPO listing: RM61.0mn Free Warrants issued : 58.7mn CORPORATE STRUCTURE The figure below illustrates the group s corporate structure and the respective principal activities: Figure 2: Corporate Structure Page 2 of 12

3 Figure 3: Principal Activities Magnetronics MClean Singapore Investment holding and provision of washing, assembly and sorting services Provision of precision cleaning and Clean Room assembly and sorting services to the HDD and semiconductor Techsin Singapore Investment holding and provision of precision cleaning services and assemblies of HDD products Clean Room injection moulding and provision of precision cleaning and Clean Room assembly Techsin Wuxi sorting services to the HDD and semiconductor industries BUSINESS DESCRIPTION MClean is principally engaged in two business activities, precision cleaning services, and 2) plastic injection moulding. Its business operation is based in Singapore and Wuxi, the PRC. Techsin The Wuxi plant house Mclean s plastic injection moulding business whereas in Singapore, the group is more focused on precision cleaning business. Various industries rely on precision cleaning such as aerospace, automotive, semiconductor, HDD, precision optics and ophthalmic, precision engineering, metal, solar panel and medical. Figure 3: Summary of Mclean s business activities Principal Activities Description Precision Cleaning Precision cleaning of the HDD components, HDD components trays, media cassettes and water carriers Precision Injection Moulding Production of plastic injection mouldings for components of HDD such as filters, media cassettes and trays as well as components for other industries such as the automotive, electronic and electrical industries (e.g. light guides, lenses, etc.). Figure 4: HDD Components for Precision Cleaning Page 3 of 12

4 Figure 5: Precision Cleaning Process Figure 6: HDD Value Chain for Precision Cleaning Page 4 of 12

5 Figure 7: Products manufactured for plastic injection moulding 27/04/11 Figure 8: Process of Plastic Injection Moulding An Regional Player As highlighted previously, MClean offers two types of services, i.e. precision cleaning and plastic injection moulding. Precision cleaning is the group s major revenue contributor accounting for 84% of the group s total sales. Plastic injection moulding accounted for the remaining l6%. Its customer base is concentrated in three countries, i.e. Singapore, Malaysia, PRC which cumulatively accounted 96% of the group revenue. Singapore is the largest contributor (54.1%), followed by Malaysia (22%) and PRC (20%). Market coverage wise, the precision cleaning operation is based in Singapore and Techsin Wuxi, the PRC. Meanwhile, the plastic injection moulding operation, it is only based in Techsin Wuxi, the PRC. Page 5 of 12

6 Figure 9: Revenue Breakdown by Business Operation (FPE10) Figure 10: Revenue Breakdown by Country (FPE10) Figure 11: Market Coverage Page 6 of 12

7 Key Facilities The Group owns several plants and equipments in Singapore and Wuxi, the PRC. We summaries below the operating facilities currently owned by the group. Figure 12: Location of plants - MClean Singapore Key Plant & Equipment Size / Capacity Purpose Cassette Washing 3 Lines 907,400 units per month Tray Washing 1 Line 663,000 units per month Precision cleaning for HDD components, HDD trays and HDD media cassettes Clean Rooms 2 Units Combination of 7,000 sq. ft. DI Water Purification Plant 1 unit 40 gallon / min Figure 13: Location of plant 1 - Techsin Wuxi Key Plant & Equipment Size / Capacity Purpose Cassette Washing 2 Lines Tray Washing 1 Line Clean Rooms 4 Units DI Water Purification Plant 1 unit Electric Injection Machine 6 units Hydraulic Injection Machine 9 units 468,000 units per month 520,000 units per month Combination of 5,648 sq. ft. 15 gallon / min tonnes Precision cleaning for HDD components, HDD trays and HDD media cassettes Manufacture of plastic moulding using electric power for higher precision level Manufacture of plastic moulding using hydraulic power for lower precision level Future Expansion The group intends to expand the PRC facility and has allocated RMB900k (approximately RM0.4mn) for the expansion plan. Total capacity is expected to increase by 15% after the completion of the expansion. The new plant will be used to rearrange the precision cleaning operation from the old plant to the new plant. The existing plant will focus on the plastic injection moulding whereas the new plant will focus solely on the precision cleaning operation. Page 7 of 12

8 Figure 14: Facilities Expansion Plan PRC Key Plant & Equipment Location Size / Capacity Purpose Clean Rooms 3 units Combination of 10,717 sq. ft. Precision cleaning for HDD Cover Washing 4 million covers components, Wuxi, the PRC 1 Line per month HDD trays and CO₂ Cleaning Line 2 Lines 576,000 units per month HDD media cassettes MAJOR CUSTOMERS MClean has two main customers which are Seagate Group and Donaldson. These two main customers contribute more than 43% to the group s total revenue. Individually, Seagate and Donaldson each contributed approximately 34.2% and 9.1% of the consolidated revenue for the FY10. MClean has long term and stable business relationships with Seagate and Donaldson. Both of these companies have been a customer of MClean since MClean provides media cassette precision cleaning and other clean room related services to Seagate Technology International, which is based in Singapore. Cleaning of media substrate cassettes services was procured by Seagate International Johor (M) Sdn Bhd. As for Donaldson, MClean provides plastic injection moulding of filter housing and cleaning of filters. Figure 15: Customers Breakdown (FPE10) Major Customers Percentage Of Mclean s Proforma Total Revenue (%) FPE 2010 Total Revenue (RM 000) 29,576 Seagate Technology International 22.5 Seagate International Johor (M) Sdn 11.7 Bhd Donaldson 9.1 Nidec Singapore Pte Ltd ( Nidec ) 11.3 Hoya Magnetics 6.6 MI Technologies 5.3 MAJOR SUPPLIERS The group s major suppliers are based in Singapore. The group s top supplier is YTH Transasia Pte Ltd ( YTH ), making up 17.6% to the total purchases for FY10. Cleaning room packaging materials are the major raw material for the group. Figure 16: Suppliers Breakdown (FPE10) Percentage Of Mclean s Proforma Major Suppliers Total Purchases (%) FP10 Total Purchases (RM 000) 8,608 YTH Transasia Pte Ltd ( YTH ) 17.6 Décor Industries Pte Ltd ( Detor ) - Statclean Technology (S) Pte Ltd 0.2 ( Statclean ) Page 8 of 12

9 Figure 17: Investment SWOT Strengths Experience management team (>10 years of experiences). Market leader in providing cleaning outsourcing services in Singapore. Advance technology and technical expertise for the services provided. Weaknesses Too dependent on certain customers / suppliers. Over-dependence on HDD market demand and customer requirement. Rely too much on the cleaning machines and equipments. Dependency on Key Management. Opportunities Upward trend of precision cleaning services. Strong PRC precision cleaning market demand for industry especially in PRC (CAGR of 11.4% between 2011 and 2015). Global HDD shipment increased 52% from 2011 to 1,125mn units in Threats Fluctuation in gross profit margins. Fluctuation in foreign exchange. Risk of termination or nonrenewal of leased properties. Parallel entry to market by domestic players. MAJOR FUTURE PLANS Page 9 of 12

10 OUTLOOK We expect demand for MClean s services to grow ahead underpinned by buoyant outlook for the storage technology. According to Frost & Sullivan, the global shipment for HDD is expected to further grow to roughly 820mn in 2012 from 640mn in The mobile computing segments and highdefinition entertainment sectors are estimated to grow in demand as well. Besides, the recycle cleaning demand is expected to be driven up due to the increasing cost of raw materials for polymer. MClean Singapore has strong position in South East Asia where it is the top producer for HDD media supplying nearly 50% of the global requirement. Apart from that, MClean foresees the potential of growth market in PRC, Techsin Wuxi due to the low cost operation matters in PRC; therefore, in this coming period, the group will focus their business in the PRC. Other than Techsin Wuxi, PRC, Malaysia has stable and well-built in semiconductor industry as well. But Industry Fragmentation Means Stiff Competition Nonetheless, we gather that there are no barriers to entry into this industry, which typically characterised by stiff competition and low margin. According to IMR report, the PRC has over 120,000 machinery enterprise and research institutions that employ 20mn labours. The country also holds a large pool of precision manufacturers which are easy to diversify into the precision cleaning business as they already have the machineries and the technical know-how. Furthermore, these manufacturers have in-house capabilities to conduct precision cleaning for clean room specifications. Thus, we opine that MClean may face stiff competition from these potential competitors. FINANCIAL HIGHLIGHTS Despite the flattish trend in revenue growth, MClean was able to increase its profit margin in FY09 due to lower labour costs and cost-cutting measures undertaken by the group. In line with the recovery of the industry in 2010, MClean achieved a YoY revenue growth of 60.2% for the 10 months FY10. The group s gross profit has also increased significantly, attributable to the economies of scale arising from the utilisation of fixed factory overheads following the increase in revenue as well as an increase in clean room assembly services which generally fetch higher gross profit margin. We expect MClean to register revenue and core net profit of RM35.5mn and RM6.2mn respectively in FY10. For FY10-FY12 we expect the group s earnings to grow by a compounded annual growth rate (CAGR) of 15.8%. Revenue is projected to reach RM37.7mn and RM40.0mn in FY11 and FY12, respectively. The growth in revenue will driven by the facilities expansion in PRC, which will increase MClean s total capacity by 15%. Nonetheless, the increased in bottomline has been offset by the higher effective tax rate as following the expiry of the preferential tax rate in Wuxi operation. According to the prospectus, Techsin Wuxi currently enjoys preferential tax rate of 12.5%. However, the subsidiary will revert to paying the full tax rate (25%) from FY12 onwards. Page 10 of 12

11 Figure 18: Revenue vs. Net Profit (RM mn) FY08 FY09 FY10E FY11F FY12F (2) (4) 27/04/11 Revenue (LHS) Core Net Profit (RHS) Sweet Deal In Warrants As a sweetener, shareholders who subscribe to the IPO are entitled for free warrants. There are total of 58.7mn warrants issued where 51mn of warrants is for the shareholders of MClean and another 7.7mn warrants are issued for the IPO investors. The free warrants issued for the IPO investors is on the basis of one warrant for every two shares successfully applied for at the price of RM0.52. The tenure period for the warrants is 5 years. At the IPO price, the Black Scholes model implies a warrant fair value of RM0.26, assuming volatility of 50%, risk free rate of 4% and zero dividend. Valuations Based on its IPO price of RM0.52, we estimate that MClean will trade at 12.3x FY11 PER and 11.0x FY12 PER. We think this is on high side vis-à-vis its closest listed competitors that are only trading at an average market cap weighted average PER of 7.0x and 5.4x in CY11 and CY12 respectively. We believe the stock should be closely valued to the industry average, if not lower, given its comparatively smaller market cap price of RM0.52). Hence, we peg the fair PER for Mclean at 7.0x. Using the FY11 fully diluted EPS of 4.2 sen, we value the stock at RM29 sen. Rich Valuations. Do Not Subscribe While we are positive on the industry outlook, we are concerned over the competitive nature of industry, the low barrier to industry and significant reliance on a single customer (Seagate). Moreover, at 11x 12x PER, we feel valuations are demanding. On the other hand, the effective subscription price to investors after including the intrinsic value of the warrant is only 26 sen. That said, at our fair value of 29 sen for the mother share, the Black Scholes model fair value is only 5 sen and the warrants will be out of the money. Therefore, we recommend investors not to subscribe to the IPO issue. Figure 15: Peer s Comparison Table Company Name Market Cap (RM mn) Source: Bloomberg, TA Securities CY11 PER CY12 Notion Vtec JCY Eng Teknologi Simple Average PER Page 11 of 12

12 Earnings Summary (RMmn) FYE Dec 31 FY08 FY09 FY10E FY11F FY12F Revenue EBITDA PBT (2.5) Tax 0.3 (0.4) (0.8) (1.3) (1.5) Net Profit (2.2) EPS (sen) (1.9) Diluted EPS (sen)* (1.2) PER (X) (42.0) Sales Growth (%) - (1.4) Diluted EPS Growth (%) - nm EBITDA Margin (%) PBT Margin (%) (9.6) Net Margin (%) (8.5) Tax Rate (%) (11.2) (16.5) (10.1) (15.0) (15.0) * Assuming the full exercise of warrants (THE REMAINDER OF THIS PAGE IS INTENTIONALLY LEFT BLANK) Disclaimer The information in this report has been obtained from sources believed to be reliable. Its accuracy or completeness is not guaranteed and opinions are subject to change without notice. This report is for information only and not to be construed as a solicitation for contracts. We accept no liability for any direct or indirect loss arising from the use of this document. We, our associates, directors, employees may have an interest in the securities and/or companies mentioned herein. for TA SECURITIES HOLDINGS BERHAD (14948-M) MENARA TA ONE, 22 JALAN P. RAMLEE, KUALA LUMPUR, MALAYSIA TEL: / FAX: (A Participating Organisation of Bursa Malaysia Securities Berhad) Kaladher Govindan Head of Research Page 12 of 12