Silverlake Axis Ltd - CIMB Research 2018-04-25: Time For Another Look At Renewed Growth Prospects

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SILVERLAKE AXIS LTD 5CP.SI

Silverlake Axis Ltd - Time For Another Look At Renewed Growth Prospects

• Silverlake Axis (SILV) is expanding its fintech capabilities to complement its primary core banking services via the earnings-accretive acquisition of three private entities.
• Recovery in customers’ orders is within sight, in our view, with revenue recognition from delivery of contracts and recent order wins.
• Silverlake Axis enjoys recurrent income from the upkeep of banks’ core banking IT systems, which will continue for the long term in our view.
• The stock trades at 16.0x CY19F core P/E, below its historical 6-year average of 20.7x, with 7% dividend yield in FY19F (based on our estimates).
• Maintain ADD with a lower DCF-based Target Price of S$0.58 (WACC: 10.1%) following a transfer of analyst coverage.

Expanding fintech capabilities via earnings-accretive acquisition

• Silverlake Axis (SILV) has completed the acquisition of three Silverlake private entities that will beef up its digital capabilities. 
• We estimate contributions of c.RM19.2m from these entities in our FY19F net profit forecast, assuming 15% y-o-y earnings growth for these entities. This implies an 8x FY19F P/E multiple based on aggregate base consideration of RM154.9m for the acquisition, which was satisfied via transfer of 70.1m treasury shares.

Digital banking prospects in Southeast Asia

• We believe banks will progressively transform the middle and front-end layers of their IT systems as the rising use of fintechs in the payments segment may compel banks to be more innovative in their digital offerings. 
• Management believes that its latest acquisition will enhance Silverlake Axis’ digital platform offerings to capture fintech opportunities among banks and also extend its services to the non-banking sector.

Anticipate a rebound in licensing and software project services

• We expect revenue from software licensing and project services to recover in 2HFY18F from the low of RM66m in FY17 and RM28m in 1HFY18F, thanks to the start of revenue contribution from the delivery of three Thai contracts that were awarded last year, as well as recent order wins, including a core banking contract (worth above Rm100m by our estimates) from a large banking institution in ASEAN on 24 Apr 2018. We opine that this signals a recovery in customer orders, with more to come.

Core banking business still remains relevant

• Our channel checks revealed that certain major bank clients of Silverlake Axis in Southeast Asia are generally resistant to forsaking their core back-end system data centres due to high switching charges, as well as concerns about security and performance. Hence, we opine that Silverlake Axis will continue to enjoy long-term recurrent income for the upkeep of financial institutions’ core systems. 
• We assume Silverlake Axis’ maintenance and enhancement services revenue to grow by 10% p.a. in our FY18-20F forecast period.

Expect attractive 7% dividend yield in FY19F

• Silverlake Axis plans to pare down its RM238.4m equity stake in Shenzhen-listed Global Infotech Co (GIT, 300465 CH, Not Rated) by 39.3% within six months starting from 8 May 2018. 
• We believe this could add 1.1 Scts in special DPS, leading to total FY19F DPS of 3.7 Scts that translates into an attractive 7% yield

Reiterate ADD with a revised Target Price of S$0.58

• Silverlake Axis is trading at 16.0x CY19F P/E, 22% below its historical 6-year average of 20.7x. Following a transfer of analyst coverage, we lower our FY18-19F EPS forecasts by 20- 36%. 
• We reiterate our ADD call with a lower DCF-based target price of S$0.58 (WACC: 10.1%), which implies 18.6x FY19F P/E. 
• A potential re-rating catalyst is stronger-than-expected earnings growth. A downside risk is slow recovery in customers’ orders.

Looking for a rebound in licensing and services revenue growth

Recovery from slowdown in banks’ IT spending in FY18F

• Management reported an improvement in the number of customer enquiries received towards the second half of 2017 and we expect a gradual recovery in sales (combined software licensing and projects services) in FY18-19F. This is in view of contributions kicking in from the delivery of three Thai contracts awarded last year, as well as recent new order wins that include:
  1. a new core banking system contract (worth above RM100m by our estimates) secured with a large banking institution in ASEAN on 24 Apr 2018;
  2. potentially mid-sized contract win (RM70m-100m by our estimates) from the Malaysia Building Society (MBS MK, Not Rated) that was announced on 12 Apr 2018;
  3. a contract to deploy a cloud-based retail solution for Metro (Private) Limited on 19 Apr 2018.
• We forecast combined revenue of RM143m in FY19F from the software licensing and project services segments (well below the 2011-17 average of RM179m) as we expect smaller prospective contract sizes from financial institutions ahead. 
• Note that our forecasts for software licensing and project services revenue are separated from our revenue contribution estimates from the newly-acquired entities.

Prospects and disruptions in core banking

Solidly anchored in recurrent core banking business

• Core banking refers to a centralised back-end system which processes banking transactions across the various bank branches and allows customers to conduct their business irrespective of the bank’s branch. Silverlake Axis generates recurrent income from the maintenance and enhancement of these systems as banks continuously need to upkeep and upgrade their critical core systems to support their growing business. 
• The maintenance and enhancement services (MES) segment accounts for 79% of 1HFY18F revenue at RM194m and grew at a 21% CAGR in FY12-17. We expect MES revenue to grow by 10% y-o-y in our forecast period, which is within management’s guidance of 10-12%.

Will core banking systems remain relevant?

•  Our channel checks revealed that certain major bank clients in Southeast Asia are generally resistant to forsaking their core back-end system data centres due to high switching charges imposed by system integrators. There have been numerous media reports that banks in the US and UK are allegedly giving up their data centres and shifting to cloud-based systems that would reap long-run cost savings. However, we believe banks in Southeast Asia will prioritise investments in digital and mobile experience instead, to compete in digital customer acquisition. 
• According to a PricewaterhouseCoopers (PwC) report in 2017, Asia has the largest unbanked population (c.47% of total population in India and c.64% in Indonesia). These are significantly greater proportions compared to the U.S. (c.20%) and UK (c.5%). Hence, we opine that Silverlake Axis will continue to enjoy long-term recurrent income from financial institutions in its key Southeast Asian market for the upkeep of their core systems.
• That being said, we believe banks will progressively transform the middle and front-end layers of their IT systems to embrace current digital innovations and open banking – allowing third-party developers to build applications and services around financial institutions and giving consumers ownership over their financial data. 
• Management believes that the newest acquisition will enhance Silverlake Axis’ digital platform offerings to capture fintech opportunities among banks and also extend its services to the non-banking sector.

Digital banking prospects in Southeast Asia

• According to a 2017 report by Capgemini (CAP FP, Not Rated) and BNP Paribas (BNP FP, Not Rated), emerging markets are expected to grow three times faster than developed economies in terms of digital transaction volumes. Digital payments in developing markets grew by 21.6% between 2014 and 2015, compared to a 6.8% increase in mature markets. The rise of fintechs in the payments area could compel banks to be more innovative in their digital offerings. Digital invoicing, virtual payment cards and cloud-based accounting are becoming more popular in emerging Asian economies, according to media reports.
• Silverlake Axis serves several major banks in Southeast Asia. For example, CIMB Group (CIMB MK, Not Rated) aims to launch its first full-digital bank this year starting in Vietnam and subsequently the Philippines. 
• With digital banking, traditional banking activities that were previously only available to customers at a bank branch will be moved to an online platform, including money deposits, financial production applications and bill payments. We expect to see an accelerated push for digital banking in developing markets in Southeast Asia going forward.
• Indonesia’s banking scene is also seeing a digitisation push. DBS Group (DBS SP, Add, TP: S$29.00) reported higher returns from its digital customers in 1H17, and it recently launched a digital bank in Indonesia. We believe this could propel Indonesian banks to shift towards digital banking. This hints at future opportunities for SISilverlake AxisLV which counts Bank Mandiri (BMRI IJ, Add, TP: Rp9,800) as a customer; the bank uses its software systems.

Latest fintech acquisition

Expanding fintech capabilities

• The three Silverlake private entities were 70%-owned by the group chairman, Mr. Goh, and do not form part of Silverlake Axis. The remaining 30% interest in these entities is held by individual stakeholders. The entities, namely Silverlake Digital Economy Sdn Bhd (SDE), Silverlake Digitale Sdn Bhd (SDS) and Silverlake One Paradigm Sdn Bhd (SOP), were identified as acquisition targets that will plug the gaps in the group’s digital banking platform offerings, which should lead to synergies and enhancement of Silverlake Axis’ overall digital capabilities. 
• End-customers of the acquisition targets include established financial institutions such as Krungthai Card PCL (KTC TB, Reduce, TP: THB143.00), OCBC Bank (Malaysia) Bhd (a subsidiary of Oversea-Chinese Banking Corporation Limited, OCBC SP, Add, TP: S$14.00), CIMB Bank (a subsidiary of CIMB Group) and Hong Leong Bank (HLBK MK, Reduce, TP: RM16.00). The acquisition of the entities was formally completed on 18 Apr 2018.

Earnings-accretive acquisition

• Consideration for the acquisition comprises: 
  1. a base component and 
  2. an earn-out consideration component based on earnings multiple applied to the net profit of each entity. 
• The base consideration of RM154.9m was satisfied by the issuance of c.70.1m treasury shares, with Silverlake Axis currently holding about 21.3m of shares in treasury post-acquisition, at a price of S$0.71 per share. 
• Based solely on the base consideration amount of RM154.9m and our earnings forecast of RM19.2m derived in total from the three entities (assuming 15% y-o-y growth in FY19F), this translates into an 8.1x FY19F P/E multiple for the acquisition.

Details on earn-out consideration

• The earn-out consideration in respect of each entity will be payable provided the relevant entity achieves an average of 25% y-o-y growth in net profit over the reference period from beginning-Jan 2017 to end-Jun 2020F. The earn-out consideration will be based on agreed multiples of average net profit generated over the aforesaid period, less the base consideration for the relevant entity. 
• Given the scenario whereby over 50% y-o-y average growth is achieved over the reference period, the implied FY19F P/E multiple would be 14x (assuming c.RM36.4m in total FY19F net profit from the private entities), which still represents an earning-accretive acquisition.

Paving the way for new leadership

• Silverlake Axis has announced that Ms Goh Shiou Ling, daughter of the current Group Executive Chairman, will be redesignated from Non-Executive Director to Executive Director. 
• In addition, the company appointed a new Managing Director for core banking of the group on 16 Apr 2018. We believe that these new appointments will facilitate the group’s focus on expanding its operations post acquisition of the three private entities.

FINANCIAL FORECASTS

Gross/net margin and net profit assumptions

• Apart from project services which we anticipate some recovery in gross profit margin to c.35% level in our forecast period, we expect gross margins in other segments to remain fairly stable. 
• In view of Silverlake Axis winning more customers’ orders in FY18F onwards, we forecast Silverlake Axis’ core net profit to return back to growth track.

Robust balance sheet with dividend yield of 7%

• As at end-Dec 2017, Silverlake Axis was in a net cash position of RM590.6m, c.14% of its current market cap. Net cash includes its RM238.4m equity stake in Shenzhen-listed Global Infotech Co (GIT, 300465 CH, Not Rated), which Silverlake Axis plans to pare down by 39.3% within six months starting from 8 May 2018. 
• We believe this could add 1.1 Scts in special DPS, leading to total FY19F DPS of 3.7 Scts that translates into an attractive dividend yield of 7%.

VALUATION & RECOMMENDATION

Reiterate Add with Target Price of S$0.58

• We reiterate our ADD recommendation in view of renewed earnings growth prospects from fintech opportunities and transformation of IT systems from banks in Southeast Asia. 
• Silverlake Axis is trading at 16.0x CY19F P/E, below its historical 6-year average of 20.7x, during its high-growth period in FY12-17 as well as below global peers’ average of 21.6x. Our Target Price of S$0.58 implies 18.6x FY19F P/E. 
• A potential re-rating catalyst is stronger-than-expected earnings growth. 
• A downside risk is slow recovery in customers’ orders.

Colin TAN CIMB Research | http://research.itradecimb.com/ 2018-04-25

SGX Stock Analyst Report ADD Maintain ADD 0.58 Down 0.650