StarHub - CGS-CIMB Research 2018-09-05: Fortifying The Cyber Security Business

StarHub - CGS-CIMB Research 2018-09-05: Fortifying The Cyber Security Business STARHUB LTD SGX:CC3

StarHub - Fortifying The Cyber Security Business

  • StarHub’s move to merge its cyber security business with Temasek’s may put it in a stronger position to capture future opportunities in a fast-growing market.
  • Near-term earnings accretion may be mild. Marginal impact on net debt/EBITDA.
  • Maintain ADD with an unchanged Target Price of S$1.85.

StarHub and Temasek to join forces on cyber security

~ ~ Where SG investors share
  • StarHub and Leone Investments (indirect wholly-owned subsidiary of Temasek) will jointly form Ensign InfoSecurity Pte Ltd. StarHub will inject its 100% stake in Accel Systems & Technologies Pte Ltd (ASTL) and its Cyber Security Centre of Excellence (COE) into Ensign for a S$120m valuation, to be paid with 104m new Ensign shares (40% stake) and S$16m in cash. Leone will inject in its 100% stake in Quann World Pte Ltd, a managed security services provider, at a S$140m valuation and also pay S$16m in cash, in return for 156m new Ensign shares (60% stake).
  • Post-completion of the asset injections, Leone will assign to StarHub the rights to a 20% stake in Ensign for S$52m cash (“Assigned Rights”). This will raise StarHub’s economic interest in Ensign to 60%, making it a subsidiary. The Assigned Rights will automatically terminate at the end of Year 5 (from completion date), with Leone to pay StarHub the fair market value. The Assigned Rights have been structured into the deal to incentivise StarHub to focus its efforts on growing Ensign over the next five years.
  • The exercise is expected to be completed by end-Oct 2018. Net cash outlay for StarHub would be S$45.8m, consisting of payments of S$52m for the Assigned Rights and S$9.8m to buy out ASTL’s current minority shareholders, plus S$16m received as part payment for its asset injection into Ensign.

Merged entity may be better placed to vie for cyber security jobs

  • According to StarHub, the merger will create one of Asia’s largest cyber security companies that will be able to deliver end-to-end solutions, putting it in a stronger position to vie for government/enterprise contracts in Singapore and overseas.
  • StarHub says Ensign should generate revenues in excess of S$100m p.a. based on the current combined orderbook and attain low double-digit net profit margins. StarHub said the deal would be earnings accretive but it did not provide a detailed guidance.

Financial impact analysis

  • Assuming S$100m revenue and 15-20% net profit margin, Ensign may record S$15m- 20m net profit. Based on StarHub’s 60% stake, its share of earnings would be S$9m- 12m. Compared to the annualised net profit of S$6.1m for ASTL and COE (1H18: S$3.0m) and considering interest income foregone on the net cash outlay, we estimate the net profit accretion to be S$2.5m-5.5m, or 2-3% of our current FY19F net profit.
  • StarHub should be able to fund this deal with the S$245m cash sitting on its balance sheet at end-2Q18. We estimate StarHub’s net debt/EBITDA by end-FY18F would only rise slightly from 1.3x to 1.4x, if we factor in the net cash outlay.

Maintain ADD with unchanged DCF-based target price of S$1.85

  • No change to our earnings forecast, as we see only mild earnings accretion from the deal. Still, we are positive on this move as it may put StarHub in a better position to capture opportunities in the fast-growing cyber security market in Singapore/regionally.
  • Maintain ADD with an unchanged target price of S$1.85.
  • A milder-than-feared impact from TPG and the delivery of material cost savings by mid-2019 would be positive for the share price, in our view. StarHub is trading in line with its 10-year EV/OpFCF mean in FY20-21F when earnings hit a trough.
  • Downside risk: keener competition.

FOONG Choong Chen CFA CGS-CIMB Research | 2018-09-05
SGX Stock Analyst Report ADD Maintain ADD 1.850 Same 1.850