When the new management (Lok Wai San & Albert Ng) took over in 2011, they began a multi-year corporate restructuring process and invested heavily in R&D at the expense of short term pain (FY12,13,14 net loss was -S$1.38m, -S$4.07m, and -S$34.6m respectively).
In light of recent events, it seems that the efforts of management has paid off and AEM is ready to rise from the ashes. The company turned in a profit of S$5.7m for FY15 and now possess tremendous growth opportunities over the next 10 years. This is due to its new flagship product (from years of R&D) known as the “high-density test handler”.
At S$0.85 per share, AEM is valued at only S$36.3m. With a ttm P/E of 4.35x, I believe this company is greatly undervalued and has the potential to be a multi-bagger.
AEM designs and builds manufacturing equipment for the semiconductor industry. It has two core businesses, Equipment Systems Solutions (ESS) and Precision Component Solutions (PCS). For FY2015, ESS contributed 86% in revenues while PCS contributed 12%. The “high-density test handler” is under ESS. Sales are mainly in USD while expenses are in SGD and MYR.
Co-developed with Intel (a key customer of AEM) since 2011, the “high-density test handler” significantly reduces the cost of manufacturing semiconductors by testing multiple chips in a single machine compared to individual chip testing in multiple machines. Furthermore, AEM owns the intellectual property rights and is allowed to sell the test handler to other customers besides Intel. This means that AEM is the only company in the world able to produce the “high-density test handler”.
After 5 years of R&D and collaboration with Intel, AEM has just begun its commercialisation phase for its new test handlers, is already ramping up production, and increasing engineering headcount. While the sale capital equipment is a low margin business, there will be recurring income in the years ahead from selling consumables used with these machines.
Aside from the core businesses, on July 21 2016, AEM took a 21% stake in Novoflex (privately-held co.). Novoflex is “essentially an outsourced assembler and tester of chips that are embedded in credit cards and debit cards”. However, the underlying potential of Novoflex is in its intellectual property; the technology to produce low-cost SIM cards for mobile phones. Management says that production of the new SIM cards will commence very shortly and that it will be disruptive and revolutionise the prepaid industry. Synergies will arise as AEM will produce the new capital equipment for Novoflex.
According to Gartner, semiconductor CAPEX is forecasted to improve after two years of lacklustre growth. This certainly bodes well for AEM.
Loke Wai San – Non-Exec Chairman & Non-Excec Director: Founder and Managing Director of a private equity fund adviser Novo Tellus Capital Partners. The Novo Tellus Fund 1, L.P., is the sole member of Orion Phoenix which has a 27.31% stake in AEM. This means Novo Tells Capital Partners has the largest stake in the business.
Charles Cher – Exec Director & CEO: Joined AEM in Apr-14. Formerly the CEO of ASTI Holdings Ltd. and CEO of Advanced Systems Automation Ltd, has more than 25 years of global semiconductor and corporate management experience. Owns 275,500 shares (0.63%) of AEM.
Management have been aggressive with their corporate restructuring since taking over AEM. For instance, in FY14 they disposed of their subsidiary, MCT, which was running losses for several years, to fund the growth of their core equipment and services business. In FY15, they exited from the stagnant plating business to further support its growth in its core businesses.
Management has also been aggressively conducting share buybacks, which signal their confidence in the growth narrative of AEM. As at 28 Dec 2016, the last time AEM bought back shares, it held 2,347,500 treasury shares (5.2% of total issued shares) vs. the maximum 4,403,943 authorised for purchase (9.76% of total issued shares). At end-FY15, it held only 1,101,500 treasury shares (2.44% of total issued shares).
The highest price paid for the share buyback was S$0.85 on 13 Dec 2016 (and 28 Dec 2016). This provides investors with a good price/support level at which AEM can be thought to be undervalued by management.
Revenues and Net Profit has turned around since FY15.
Cashflow from Operations turned positive in LTM Ending 30 Sep 16 while CAPEX requirements has declined substantially over the years since the new management took over in 2011.
Total Debt/Equity has been steadily decreasing, insulating it from a rising interest rate environment. ROE has since turned around to reach above 25% in FY15. Net Income Margins, as expected from a capital equipment business, have been in the low teens (10-12%).
Note: As at 30 Sep-16, AEM had debts of S$106k with cash and cash equivalent of S$8.4m. However, due to its large working capital requirements (i.e. high levels of current liabilities), the company is NOT in a net cash position.
4th Jan 17 Update: AEM’s order-book has grown by more than 10-fold since start of FY14 to beginning of FY17. From Mar-16 to Jan-17, AEM’s order-book more than trebled from S$24.5m to S$84.5m. This acceleration of growth in order-book underpins the tremendous earnings growth potential for AEM in coming years, or at least in 2017.
Given the successful turnaround and stellar growth prospects of AEM, its valuations are surprisingly low. I believe if AEM continues to deliver strong earnings growth, the market will wake up to this undervalued gem.
Using ttm. EV/EBITDA multiple of 6.5x (from UMS), AEM could potentially be worth S$1.19 (40% upside). Market Cap of AEM will be S$50.8m. No earnings growth assumed.
Using hist. P/E multiple of 9.6 (lower than UMS’ 9.8x), which was the P/E multiple of AEM when it IPO-ed in 2000, the business could potentially be worth S$1.85 (118% upside). Market Cap of AEM will be S$79m (similar to AEM post-IPO Market Cap of S$74m). No earnings growth assumed.
Given the accelerating growth in sales order-book and positive industry tailwinds; assuming earnings growth of 50% in FY17 and a P/E multiple of 9.6, AEM could potentially be worth S$2.78 (227% upside). Market Cap of AEM will be S$118.6m.
Note: None of the scenarios include the potential earnings contributions from Novoflex.
- Early phase of ramping up production of its “high-density test handlers”
- Owns intellectual property rights to said product
- Positive industry tailwinds
- Management with significant stake in the business
- Frequent & Consistent Share Buybacks
- Revenue, Net Income, and Cashflow from Operations have turned around/positive
- Low CAPEX requirements & debt levels
- Improved profitability with increasing sales order
- Multi-bagger: Potentially worth between S$1.19 (40% upside) to S$2.78 (227% upside)
- Semiconductor Industry is a volatile and cyclical one
- Customer concentration and cancellation risk: One customer (Intel) accounted for 80% of its total revenue in FY15. Any order cancellation or postponement by Intel will severely affect AEM’s profitability. However, such a scenario is very unlikely due to the dominant position of Intel (largest chip-maker in the world) in the semiconductor industry and the long-term strategic relationship between the 2 companies.
- Low margin capital equipment business
Disclaimer: I own shares in AEM Holdings.