Taiwan Industrial PC Sectorasiaresearch.daiwacm.com/eg/cgi-bin/files/Taiwan... · 23 March 2016...

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Taiwan Information Technology

23 March 2016

Taiwan Industrial PC Sector

Initiation: now they’re talking

We highlight the Industrial PC sector as a major beneficiary of the ongoing rise of the Internet of Things (IoT)

The Industrial IoT megatrend, government-led efforts to modernise industrial bases, and M&A should be the key catalysts for the sector

We favour Ennoconn for its strong earnings and Advantech for its industry leadership; concerns over IA demand and opex for Adlink

Steven Tseng(886) 2 8758 6252

[email protected]

Jack Lin(886) 2 8758 6253

[email protected]

2

Taiwan Industrial PC Sector: 23 March 2016

Table of contents

Industry dynamics .................................................................................................... 6

Industrial IoT seen as a key demand driver ........................................................................6

Policy initiatives driving industry upgrades ....................................................................... 11

Vibrant M&A activity ......................................................................................................... 13

Valuations and recommendations .........................................................................16

Favourable valuations set to continue .............................................................................. 16

Stock recommendations .................................................................................................. 17

Risks to our view .............................................................................................................. 18

Company Section

Ennoconn ........................................................................................................................ 19

Advantech ........................................................................................................................ 30

Adlink Technology ........................................................................................................... 39



Investment case: We expect the IoT and industrial modernisation

megatrends that are now gathering pace to propel Taiwan’s Industrial PC

(IPC) sector to new heights. Within the sector, we prefer the leading

players, which we believe are the best placed to benefit from industry

consolidation and tap emerging IoT-related growth opportunities.

Catalysts: Industrial IoT: key demand driver. Industrial IoT (IIoT)

describes automated/intelligent processes which are enabled by huge sets

of data from the connected devices used in industrial applications. While

Consumer IoT has understandably become an important investment

theme, we believe that IIoT will have a bigger immediate impact in terms of

business opportunities and revenue contributions for the IPC sector.

Policy push for industrial upgrades. Governments worldwide have been

unveiling long-term strategies to modernise their countries’ industrial bases.

We believe that these blueprints, exemplified by Industrie 4.0 (Germany)

and Made in China 2025, will stimulate demand for industrial upgrades,

thereby presenting a sizeable opportunity for the IPC sector.

Vibrant M&A activities. M&A is becoming the preferred route for IPC

players seeking to equip themselves with new skills and industry

knowledge as IIoT-related opportunities come to the fore. We believe this

M&A activity will spur industry consolidation, which should benefit the

biggest players in the sector. Although we expect M&A to be positive as

synergies are realised in the long term, investors should be mindful of

execution risks and the likely impact on margins in the short term.

Valuation: We expect these emerging industry trends to support sustained

profitability at the company level and, in turn, the sector’s valuation over

our investment horizon. We initiate coverage of Ennoconn (6414 TT,

TWD384) with a Buy (1), as we expect its focus on the ODM business,

proactive M&A strategy, and strong support from the Hon Hai group to

result in solid earnings growth and a superior ROE for 2016-17. We also

like Advantech (2395 TT, TWD235), whose industry leadership we think

puts it in a strong position to ride the IIoT trend; upgrading to Outperform

(2) from Hold (3). On Adlink Technology (6166 TT, TWD76), however, we

are concerned about lingering weakness in demand in its bread-and-butter

industrial automation (IA) business, as well as likely worse-than-expected

opex as a result of its recent acquisition and employee stock plan.

Risks: Compared with the consensus, we are more upbeat on the earnings

prospects of Ennoconn and Advantech, but more cautious on Adlink.

23 March 2016

Taiwan Industrial PC Sector

Initiation: now they’re talking

We highlight the Industrial PC sector as a major beneficiary of the ongoing rise of the Internet of Things (IoT)

The Industrial IoT megatrend, government-led efforts to modernise industrial bases, and M&A should be the key catalysts for the sector

We favour Ennoconn for its strong earnings and Advantech for its industry leadership; concerns over IA demand and opex for Adlink

Key stock calls

Source: Daiwa forecasts

Steven Tseng(886) 2 8758 6252

[email protected]

Jack Lin(886) 2 8758 6253

[email protected]

New Prev.

Ennoconn (6414 TT)Rating Buy

Target 481.00

Upside p 25.3%

Advantech (2395 TT)Rating Outperform Hold

Target 254.00 212.00

Upside p 8.1%

Adlink Technology (6166 TT)Rating Underperform

Target 68.00

Downside q 10.5%

4


How do we justify our view?

Growth outlook Valuation Earnings revisions

Growth outlook Worldwide industrial PC market size

According to market research institution IHS, the worldwide

IPC market will be worth some USD3.6bn in 2016E (up

7.0% YoY) and see a CAGR of 7.4% from 2014 to 2018.

While the growth prospects appear modest, we expect the

implementation of IIoT, which is still in its early stages, to

bring significant upside to the IPC sector in the long run.

Over our forecast horizon, we expect the leading IPC

companies to continue gaining market share and to

outgrow the overall industry amid industry consolidation.

Source: IHS

Valuation Taiwan IPC sector: sector PER bands

Taiwan’s IPC sector was trading at a 1-year-forward PER

of less than 12x prior to 2013, but it experienced a rerating

and has been trading within a range of 17-25x since 2014.

We believe the rerating has been driven by: 1) favourable

transition in the manufacturing- and industrial- related

sectors towards smart/intelligence automation in recent

years, 2) the overall sustainable profitability of the IPC

sector, and 3) positive catalysts from M&A activity in the

sector.

Going forward, we expect these positive factors will

continue to support the sector’s valuation.

Source: Bloomberg, Daiwa forecasts

Earnings revisions IPC sector: Bloomberg consensus 2015-16E EPS revisions

The 2015-2016 Bloomberg consensus earnings forecasts

for Taiwan’s IPC sector have shown a general downward

trend since mid-2015. In our view, these revisions are likely

to reflect investors’ increasing concerns about the global

economic outlook in 2016, as well as the short-term

financial impact of some IPC companies’ M&A activity

undertaken in 2014-15.

We foresee scope for positive revisions to the market’s

forecasts, as we believe visibility on the market’s prospects

for 2016 will improve as implementations of IIoT

applications continue to proliferate and synergies from IPC

companies’ M&A moves start to materialise.

Source: Bloomberg

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2013 2014 2015 2016E 2017E 2018E

IPC Market Size IPC Market Size Growth YoY

(USDbn)

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Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16

(USDbn)

Market Cap 8x 12x

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2015 Index 2016E Index

5


Sector stocks: key indicators


Industrial PC sector: valuation metrics

Company Ticker Daiwa Price Mkt cap PER (x) ROE (%) PBR (x) EPS Growth (%) PEG Ratio

Rating (local currency) (USDm) 2014 2015 2016E 2014 2015 2016E 2014 2015 2016E 2014 2015 2016E 2014 2015 2016E

Taiwan IPC plays

Advantech* 2395 TT Outperform 235.00 4,586 30.2 29.1 24.1 23.6 22.4 25.0 6.6 6.4 5.7 6.7 3.9 20.9 4.50 7.47 1.15

Ennoconn* 6414 TT Buy 384.00 827 46.9 30.9 20.7 31.2 31.0 35.0 10.9 8.5 6.3 33.1 51.7 49.1 1.42 0.60 0.42

Adlink* 6166 TT Underperform 76.00 509 23.7 25.1 24.6 17.3 16.2 13.7 3.9 3.9 3.0 20.5 -5.5 1.9 1.15 -4.54 12.94

Flytech 6206 TT Not-rated 116.50 527 16.9 16.6 15.4 24.4 23.5 24.0 4.0 3.7 3.6 8.1 1.6 7.5 2.09 10.18 2.06

IEI 3022 TT Not-rated 41.30 419 9.2 10.0 9.4 20.8 18.0 20.3 1.9 1.8 n.a. 32.1 -8.6 6.7 0.29 -1.16 1.41

Posiflex 8114 TT Not-rated 162.50 339 18.9 17.8 15.9 36.7 35.6 35.6 6.6 6.1 5.4 14.3 6.3 12.1 1.33 2.83 1.32

iBase 8050 TT Not-rated 56.80 200 14.7 12.8 12.0 18.3 19.1 20.8 2.6 2.5 2.2 48.0 14.8 6.7 0.31 0.86 1.79

Axiomtek 3088 TT Not-rated 76.30 186 16.1 14.2 12.9 25.3 26.1 25.1 3.8 3.6 3.2 36.9 13.3 10.2 0.44 1.07 1.26

Global IPC plays

Kontron KBC GR Not-rated 3.00 188 27.3 54.5 18.9 -2.5 0.2 1.9 0.7 0.7 0.6 n.a. -50.0 189.1 n.a. -1.09 0.10

Radisys RSYS US Not-rated 4.04 150 n.a. 100.0 16.2 -34.7 -20.4 n.a. 1.9 2.3 n.a. n.a. n.a. 518.5 n.a. n.a. 0.03

Source: Bloomberg, *Daiwa forecasts (market data as of 21 March 2016 unless otherwise stated)

Industrial PC sector: key assumptions

Revenue (TWDm) 2013 2014 2015 2016E 2017E

Ennoconn

ATM 1,022 1,314 1,327 1,381 1,462

YoY n.a. 28.6% 1.0% 4.1% 5.9%

POS 898 960 995 1,051 1,141

YoY n.a. 6.9% 3.7% 5.6% 8.5%

Industrial Automation 898 606 553 581 665

YoY n.a. -32.5% -8.8% 5.1% 14.5%

Telecom 0 1,314 3,428 6,943 9,937

YoY n.a. n.a. 160.9% 102.6% 43.1%

Network Securities 0 303 3,544 4,680 6,366

YoY n.a. n.a. 1069.2% 32.0% 36.0%

Advantech

Industrial Automation Services 4,264 5,325 5,632 6,696 7,911

YoY -7.1% 24.9% 5.8% 18.9% 18.1%

Embedded & Design-in Services 11,772 14,305 15,419 17,475 20,021

YoY 12.7% 21.5% 7.8% 13.3% 14.6%

Intelligent Services 3,222 3,127 3,524 6,029 7,171

YoY 62.9% -2.9% 12.7% 71.1% 19.0%

Design & Manufacturing Services (DMS) 7,553 8,929 8,801 9,662 11,466

YoY 6.0% 18.2% -1.4% 9.8% 18.7%

Global Customer Services 3,850 4,045 4,624 5,576 6,674

YoY 12.4% 5.1% 14.3% 20.6% 19.7%

Adlink

Measurement & Automation (MAPS) 1,668 2,683 2,525 2,621 3,146

YoY 8.1% 60.9% -5.9% 3.8% 20.1%

Embedded Computing (ECPS) 2,223 1,798 1,498 1,680 1,771

YoY 10.4% -19.1% -16.7% 12.2% 5.4%

Module Computing (MCPS) 1,553 1,987 2,854 3,154 3,718

YoY 7.5% 27.9% 43.6% 10.5% 17.9%

Design & Manufacturing Services (DMSC) 906 1,092 1,479 1,600 1,687

YoY 97.4% 20.5% 35.4% 8.2% 5.4%

Display Computing (DCPS) 60 314 484 626 771

YoY 172.7% 423.3% 54.2% 29.3% 23.1%

Source: Companies, Daiwa forecasts

Share

Company Name Stock code Price New Prev. New Prev. % chg New Prev. % chg New Prev. % chg

Adlink Technology 6166 TT 76.00 Underperform 68.00 3.031 3.088

Advantech 2395 TT 235.00 Outperform Hold 254.00 212.00 19.8% 8.078 7.871 2.6% 9.769 9.503 2.8%

Ennoconn 6414 TT 384.00 Buy 481.00 12.415 18.514

Rating Target price (local curr.) FY1

EPS (local curr.)

FY2

6


Industry dynamics

Industrial IoT seen as a key demand driver

Growth in the Industrial PC market looks resilient

Industrial PCs are computing products or systems (mostly Windows/Intel-based) that are

highly customised to meet the needs of certain industries or applications. Compared with

typical consumer or commercial PCs, IPCs are required to be more reliable and durable,

more readily expandable, and have much longer life cycles.

According to IHS’ forecasts (see chart below), the worldwide IPC market will be worth

some USD3.6bn in 2016E (up 7.0% YoY) and see a CAGR of 7.4% from 2014 to 2018.

While the global IPC market is far smaller than the broader PC industry (which was worth

some USD174bn as of 2015, according to IDC), we believe the IPC industry has much

more sustainable and resilient growth momentum than the PC industry, which has been

contracting steadily since 2012.

Worldwide industrial PC market size and growth forecasts

Source: IHS

Examples of Industrial PC products

Source: Companies

Traditionally, IPCs come in many form factors, including panels, boxes, racks, embedded

systems, and thin clients. Their major applications include automation, communication,

gaming, retail, banking, transportation, medical, and military/defence. While we expect

demand for traditional IPC products to remain strong, we see a much more robust growth

driver in the long term in the rise of Industrial IoT, which we believe will have a profound

impact on many industrial activities.

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2013 2014 2015 2016E 2017E 2018E

IPC Market Size IPC Market Size Growth YoY

(USDbn)

Global IPC market

should see a CAGR of

7.4% for 2014-18,

according to IHS

7


What is Industrial IoT (IIoT)?

As we highlighted in our thematic report, Big Data: the next big thing, published on 2

January 2015, Daiwa considers Big Data and IoT to be the most important drivers for

global IT demand in the coming years and indeed decades. According to Gartner’s most

recent forecasts ("Forecast: Internet of Things - Endpoints and Associated Services,

Worldwide, 2015", authors include Peter Middleton, Jim Tully, Kenneth Brant, Eric

Goodness, Anurag Gupta, Jim Hines, Thilo Koslowski, Angela McIntyre, Bettina Tratz-

Ryan, published on 29 October 2015), there will be 6.4bn IoT devices globally in 2016, up

30% YoY, and the total number will reach 20.8bn units worldwide by 2020, implying a

CAGR of 34%. These forecasts, which exclude the existing smart connected products that

we think of today (such as smartphones and tablets), indicate very promising growth

potential for IoT applications, in our view.

The Internet of Things: market segmentation by industry/application

Source: IoT Analytics GmbH

Industrial IoT vs. Consumer IoT

The application of IoT encompasses a broad range of market segments (see chart above).

While much of the hype about IoT centres on consumer-centric applications (ie, Consumer

IoT), such as smart homes and connected cars, we consider industrial- and business-

related IoT applications, ie, Industrial IoT (IIoT), to be equally important and potentially

more disruptive than Consumer IoT.

Simply put, IIoT involves automated/intelligent processes that are powered by massive

sets of data captured from connected devices for various industrial applications. Gartner’s

forecasts indicate that, while Consumer IoT devices should account for the majority of IoT

in terms of unit shipments (as shown in the chart, below left), Industrial IoT devices will be

more significant in terms of their value/revenue contribution (see chart, below right).

Industrial IoT presents a

promising growth

opportunity for IPC

sector, in our view

http://asiaresearch.daiwacm.com/eg/cgi-bin/files/AsiaTechSector_150102.pdf#page=1

8


IoT units installed base: industrial vs. consumer IoT spending: industrial vs. consumer

Source: Gartner "Forecast: Internet of Things - Endpoints and Associated Services, Worldwide, 2015", authors include Peter Middleton, Jim Tully, Kenneth Brant, Eric Goodness, Anurag Gupta, Jim Hines, Thilo Koslowski, Angela McIntyre, Bettina Tratz-Ryan, published on 29 October 2015

Source: Gartner "Forecast: Internet of Things - Endpoints and Associated Services, Worldwide, 2015", authors include Peter Middleton, Jim Tully, Kenneth Brant, Eric Goodness, Anurag Gupta, Jim Hines, Thilo Koslowski, Angela McIntyre, Bettina Tratz-Ryan, published on 29 October 2015

In terms of business impact IIoT could dwarf Consumer IoT

In our view, Gartner’s forecasts suggest that, compared with Consumer IoT, Industrial IoT

will likely herald more immediate and significant revenue contributions for related

companies in the coming years. In fact, we draw a similar conclusion from a study

undertaken by the World Economic Forum (WEF).

According to the WEF’s research paper, Industrial Internet of Things: Unleashing the

Potential of Connected Products and Services (published in January 2015), IIoT could

ultimately dwarf the consumer side in terms of its potential business and socioeconomic

impact. The major disruption caused by the IIoT, according to WEF, will be the creation of

value made possible by the massive volumes of data collected from connected products,

and the increased ability to make automated decisions and take actions in real time.

Some examples

The diagrams below show some examples of IIoT applications and where IPCs will fit into

the picture. By applying IIoT-related technologies, a manufacturing factory can become

more intelligent and flexible, as all the individual production processes can be seamlessly

connected (even with outsiders in the supply chain where necessary) through real-time

data exchange and sharing. As such, the equipment and machinery will have the ability to

enhance these processes through self-optimisation and autonomous decision-making.

IPCs will likely play an important role in such smart factories, given the need for data

consolidation and analysis, robotic/automation control, factory surveillance,

warehouse/logistic management, and data transmission security.

0

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25

2014 2015E 2016E 2017E 2018E 2019E 2020E

Consumer Business

(units bn)

2015-20E CAGR: 34%

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2014 2015E 2016E 2017E 2018E 2019E 2020E

Consumer Business

(USDtn)

2015-20E CAGR: 21%

Compared with

Consumer IoT, we

believe Industrial IoT will

present more immediate

and substantial business

opportunities

One example of IIoT:

smart factory

9


IIoT application and IPCs: smart factory

Source: IEI

Another example of an IIoT application is transportation (see chart, next page). By

implementing IIoT technologies, transportation systems and infrastructure can become

more efficient and intelligent through the collection and exchange of traffic-related data

among the various constituents (eg, train/bus terminals, highway/freeway control centres,

toll booths, and vehicle users). The data collected can be used to make automated

recommendations to the constituent users where necessary. Under a smart transportation

system such as this one, IPCs would support various activities related to traffic control

rooms, electric toll collection (ETC), traffic sign control, and terminal/station management.

IIoT application and IPC: transportation

Source: Advantech

Another example: smart

transportation system

10


Potentially significant upside from IIoT

The implementation of the IIoT is still in its infancy, and we believe there are likely to be

more significant opportunities and challenges for all industries as the implementation

process gathers pace. Indeed, we consider it highly likely that the existing growth forecasts

for the global IPC industry compiled by industry research institutions may not fully capture

the potential contribution of the IIoT.

Considering the significant revenue implications of the IIoT (Gartner expects total spending

on business-related IoT to reach USD868bn in 2016E) and the much smaller market size

of the global IPC sector (IHS forecasts the market to expand to USD3.6bn in 2016E), we

believe the rise of the IIoT will bring potentially sizable business opportunities for IPC

players. Central to our view is that the IPC makers’ clients from various industries are

increasingly looking for effective, potentially game-changing solutions to implement IIoT in

their businesses.

11


Policy initiatives driving industry upgrades

Aside from the emerging megatrend of IIoT, we see another favourable catalyst for the IPC

sector in major governments’ efforts to upgrade their country’s industries. In this context,

we highlight 2 good examples: Germany’s “Industrie 4.0” and China’s “Made in China

2025”.

Germany: Industrie 4.0

The German government presented its High-Tech Strategy Action Plan in 2012. Under the

plan, Industrie 4.0 is identified as one of 10 “future projects”, the requirements for which, in

the government’s view, must be addressed in the next 10-15 years.

Simply put, Industrie 4.0 is Germany’s vision for the future of manufacturing in the country,

in which smart factories use information and communications technology to digitise their

processes and, as a result, reap benefits in the form of higher quality, lower cost, and

greater efficiency. Within the modular structure of smart factories as envisaged under

Industrie 4.0, cyber-physical systems (CPS) monitor physical processes, essentially

creating a virtual copy of the physical world and then making decentralised decisions.

Through the IoT, CPS communicate and cooperate with each other, and with humans, in

real time, while via the Internet of Services both internal and cross-organisational services

are offered and used by participants across the value chain.

To support this initiative, the German government has set aside a total of EUR200m

(EUR40m annually until 2020) to encourage related research across both the public and

private sectors, as well as academia.

Industrie 4.0: the next step in the industrial revolution

Source: DFKI

The growing impact of Industrie 4.0

The concept of Industrie 4.0 has continued to evolve since its introduction, and it is now

considered in some quarters as a synonym for “the fourth industrial revolution”. Indeed,

some observers consider the initiative to be akin to the Industrial IoT, since the concept is

heavily reliant upon on the implementation of the IoT. On the heels of Germany’s

announcement of Industrie 4.0, Japan (Industrial Value Chain Initiative), Korea

(Manufacturing Innovation 3.0 Strategy Implementation Plan), and China (Made in China

2025) unveiled similar initiatives.

Germany’s Industrie 4.0

has prompted similar

initiatives by

governments and

corporates globally

12


China – Made in China 2025

In May 2015, China announced its Made in China 2025 initiative, which is considered to be

an official roadmap for the country’s plan to be one of the world’s manufacturing

powerhouses by 2025. While the plan appears to draw inspiration from Germany’s

Industrie 4.0, it also underlines China’s efforts to transform its massive manufacturing

sector in order to tackle some of the challenges now facing it, including slowing economic

growth, rising labour costs, and intensifying competition from other emerging markets (eg,

ASEAN).

Made in China 2025 is essentially a 10-year strategy to move the Mainland economy away

from labour-intensive, low-value production towards higher-value-added manufacturing,

and to this end it includes plans to foster innovation, integrate technology and industry,

strengthen the country’s industrial base, nurture Chinese brands, and enforce green

manufacturing. It also calls for breakthroughs to be made in 10 key industries where China

believes it could be a world leader in the future, including information technology, robotics,

aerospace, railways, and new-energy vehicles (see chart below).

Made in China 2025: 10 priority sectors

Source: Center for Strategic & International Studies

We expect forward-looking policies like these to be a driving factor in the process of

industrial modernisation that we expect to unfold in many industries around the world in the

coming years. The related business opportunities for the IPC sector should be significant,

in our view.

Made in China 2025

follows in the footsteps

of Industrie 4.0

13


Vibrant M&A activity In our view, another positive catalyst for the IPC sector is its recent record of M&A activity, which we see as accelerating industry consolidation and having major implications for the competitive landscape. Resilience resulting from diverse industry/client exposure Most IPC companies today are exposed to a range of industries and/or have fragmented client bases (see table below). This breadth of exposure gives the companies an opportunity to focus on areas of potential organic growth in certain segments or at certain clients, which should make the sector less vulnerable than other tech sectors to macro uncertainties but also means that, relatively speaking, it tends not to deliver substantial revenue growth.

Industrial PC sector: major players

Company Ticker Mkt cap Main Business Revenue (USDm) Major Revenue Exposure by Segments

Revenue YoY (%)

(USDm) 2015 Auto-mation

POS /ATM

Gaming Comm. Medical Trans-portation

Others 2014 2015

Taiwan Advantech* 2395 TT 4,586 The largest IPC player worldwide. Major businesses include

embedded computing cards and total IPC solutions/systems for a variety of vertical applications

1,197 16.5 6.3

Ennoconn* 6414 TT 804 The IPC arm of the Hon Hai group; focuses on ODM business for the vertical applications like telecom/networking, industrial automation, POS/ATM, etc.

348 63.2 118.9

Adlink* 6166 TT 465 The second-largest IPC brand in Taiwan, focusing on automation & measurement (for automation), networking; military; infortainment and medical.

286 24.2 12.7

Firich 8076 TT 631 Focusing on gaming machines and POS 81 3.9 1.5Flytech 6206 TT 494 Specialising in ODM business for POS 154 16.8 19.9ICP 3022 TT 401 Focusing on IPC solutions for storage, gaming, industrial

automation, medical and transportation 209 30.3 7.3

TSC 3611 TT 343 Focusing on Auto-ID and barcode printers 78 16.0 8.9Posiflex 8114 TT 317 Focusing on own-brand POS business 92 4.0 18.9iBase 8050 TT 184 Focus segments include industrial automation, gaming, digital

signage, networking security. 129 36.8 30.3

Axiomtek 3088 TT 168 Focus segments include industrial automation, transportation, gaming, and utility.

155 18.4 18.8

Avalue 3479 TT 162 Focus segments include medical, POS and gaming. 134 10.3 36.3Portwell 6105 TT 128 Focusing on gaming, POS, medical and industrial automation. 166 17.3 -5.3Nexcom 8234 TT 116 Its main vertical markets are automation, cloud computing and

automotive. 167 29.1 2.1

Lanner 6245 TT 113 Focusing on network security applications. 164 16.2 18.9Arbor 3594 TT 50 Specialises in medical and industrial automation related

applications. 42 13.7 -0.7

Overseas Kontron KBC GR 201 Germany-based company and the second-largest IPC player

worldwide in terms of revenue; specialises in industrial automation, communication, and transportation segments.

514 2.6 2.7

Radisys RSYS US

95 A US IPC player specialising in communication network segment-related hardware/software solutions

189 -19.0 -1.6

Source: Company, Bloomberg, *Daiwa forecasts Note: Market data as of 21 March 2016 unless otherwise stated

M&A to fuel non-organic growth In recent years, we have seen an upswing in M&A activity in the IPC sector (see table, next page), which we attribute largely to the megatrends of industrial modernisation and IoT. Historically, IPC companies tended to develop their knowledge of a specific industry (operations, business models, key market trends, etc.) internally when planning to enter new segments, which was a time-consuming process. Nowadays, the IPC players are keen to equip themselves with industry knowledge and skills from a range of segments, so they can tap growth opportunities related to the Industrial IoT. M&A is an efficient and effective way for the IPC companies to access such knowledge.

Vibrant M&A activity driven by industrial modernisation and IoT megatrends

14


Industrial PC sector: major M&A transactions in recent years

Time Acquirer Acquisition target Major business Deal value Post-Deal

Holding Remark

May-07 Advantech Netstar Technologies

Industrial communication OEM/ODM TWD155m 62% Merged into Advantech in 2014

Dec-08 Adlink Ampro Computers Rugged computing products, modular embedded computing solutions USD20m 100% Ampro brand maintained

Mar-10 Advantech DLoG GmbH Vehicle-mounted computers EUR12.85m 100% Co-branding: Advantech-DLoG

May-10 Advantech Broadwin Automation and smart-grid software TWD90m 70%

Nov-10 Advantech Innocore Gaming Gaming related industrial PC solutions GBP334m 100% Co-branding: Advantech-Innocore

Nov-10 Advantech ACA Digital Industrial portable products TWD93m 100%

Jan-12 Advantech Advansus Corp Industrial PC TWD306m 100% Advantech bought 50% stake in Advansus from Pegatron

Jan-12 Adlink Lippert Embedded Computers GmbH

Transportation & healthcare (brand modularised PC supplier) EUR7m 100% Maintained "Lipper" brand

Feb-12 Ennoconn AsiaTek Smart car-related products (eg, GPS/GPRS/CDMA) and intelligent transportation system (ITS)-related applications

n.a. 100% Became Ennoconn's HQ in China

Dec-12 Advantech BICOM Information Technology

Digital signage TWD60m 100%

Aug-13 Advantech AdvanPOS POS products TWD319m 70% Maintained AdvanPOS brand

Sep-13 Advantech LNC Machine control and robotics TWD730m 100% Co-branding: Advantech-LNC

Nov-13 Advantech GPEG Intelligent display GBP5.85m 100% Co-branding: Advantech-GPEG

Mar-14 Adlink PENTA GmbH Healthcare & industrial automation (medical embedded PC and HMI) mainly in Germany

USD7.4m 100% Maintained PENTA brand

Sep-14 Ennoconn GoldTek ODM & OEM for portable device customisation n.a. 55% Maintained GOLDTek brand

Oct-14 Ennoconn Caswell (6416 TT) Network storage server and security appliances mainly for network/communication sector

TWD953.1m

39% Maintained Casewel brand

Nov-15 Advantech B+B SmartWorx Industrial connectivity solutions USD99.85m 100%

Dec-15 Adlink PrismTech Software platforms and tools for IoT, mainly data distribution service (DDS) related

USD16.6m 100% Using PrismTech's "Vortex" (an intelligent data-connectivity platform)

Jan-16 Ennoconn Kontron Canada Industrial computing products/solutions for communication segment USD57.3m 49%

Source: Company, Daiwa research

M&A is spurring industry consolidation

In our view, the increasing number of M&A deals in IPC sector has also helped to

accelerate the process of industry consolidation. For example, in recent years the

combined revenues of the top 3 IPC companies in Taiwan have expanded as a proportion

of the global IPC industry while outpacing revenue growth for the industry as a whole (see

chart below). We expect this trend to continue.

Top-3 Taiwan IPC players’ global market share and YoY revenue growth

Source: IHS, Company, Daiwa estimates

Short-term pain vs. long-term gain

While most companies proceed with M&A in anticipation of realising business synergies,

execution risk remains a constant factor. In addition, such deals can have a short-term

earnings impact as the acquired entities often have very different cost/expense structures

than the acquiring companies. Looking through the historical data, we can see that M&A

tends to eat into operating margins during the quarter in which the deal occurred, and even

in subsequent quarters (see charts, next page). As for the long-term gains, our company-

level forecasts call for revenue growth and/or margin expansion for 2017E, which are partly

attributable to the benefits of M&A activities.

(5%)

0%

5%

10%

15%

20%

25%

42%

44%

46%

48%

50%

52%

54%

56%

2012 2013 2014 2015

Global Market Share of Top 3 Taiwan Players (LHS) Top 3 Taiwan Players' Revenue Growth YoY (RHS)

IPC Market Size Growth YoY (RHS)

Bigger IPC players are

driving industry

consolidation and

benefiting from it

15


Ennoconn: quarterly operating margins vs. M&A activities

Source: Company, Daiwa research Advantech: quarterly operating margins vs. M&A activities


Adlink: quarterly operating margins vs. M&A activities


0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15

AsiaTek(Sep, '14)

CaswellTWD953m(Oct, '14)

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q124Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q153Q15 4Q15

LNCTWD730m(Sep, '13)

AdvanPOSTWD319m(Aug, '13)

AdvansusTWD306m(Jan, '12)

InnocoreGBP334m(Nov, '10)

DLoGEUR12.85m

(Jan, '10)

B+B SmartworxUSD99.85m(Nov, '15)

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

1Q08

2Q08

3Q08

4Q08

1Q09

2Q09

3Q09

4Q09

1Q10

2Q10

3Q10

4Q10

1Q11

2Q11

3Q11

4Q11

1Q12

2Q12

3Q12

4Q12

1Q13

2Q13

3Q13

4Q13

1Q14

2Q14

3Q14

4Q14

1Q15

2Q15

3Q15

4Q15

AmproUSD20m (Dec, '08)

LippertEUR 7m (Jan, '12)

PentaUSD7.4m (Mar, '14)

Prism Tech USD16.6m(Dec, '15)

16


Valuations and recommendations

Favourable valuations set to continue

Positive industry trends argue for rerating

Prior to 2013, Taiwan’s IPC sector traded at around 1-year-forward PER of 12x. However,

its valuation started improving steadily in early 2013 and since 2014 the sector has traded

in a 1-year-forward PER range of 17-25x. This trend is in contrast to that for Taiwan’s PC

hardware sector (including PC OEM and notebook ODM players), which in recent years

has been trading at a 1-year-forward PER range of 10-12x and seems at risk of a further

derating, in our view.

We believe the favourable valuation trends in the IPC sector are being driven by the

following factors: 1) the ongoing shifts in the manufacturing and industrial sectors towards

smart/intelligence automation, 2) the sustained profitability of the IPC sector as a whole, in

contrast to the PC hardware sector, despite the fact that both use essentially the same

technologies, and 3) M&A activity serving as a share-price catalyst.

Taiwan IPC sector: sector PER bands Taiwan IPC sector: sector PBR bands



Industrial PC sector: valuation comparison

Company Ticker Daiwa Price Mkt cap PER (x) ROE (%) PBR (x) EPS Growth (%) PEG Ratio

Rating (local currency) (USDm) 2014 2015 2016E 2014 2015 2016E 2014 2015 2016E 2014 2015 2016E 2014 2015 2016E

Taiwan IPC plays

Advantech* 2395 TT Outperform 235.00 4,586 30.2 29.1 24.1 23.6 22.4 25.0 6.6 6.4 5.7 6.7 3.9 20.9 4.50 7.47 1.15

Ennoconn* 6414 TT Buy 384.00 827 46.9 30.9 20.7 31.2 31.0 35.0 10.9 8.5 6.3 33.1 51.7 49.1 1.42 0.60 0.42

Adlink* 6166 TT Underperform 76.00 509 23.7 25.1 24.6 17.3 16.2 13.7 3.9 3.9 3.0 20.5 -5.5 1.9 1.15 -4.54 12.94

Flytech 6206 TT Not-rated 116.50 527 16.9 16.6 15.4 24.4 23.5 24.0 4.0 3.7 3.6 8.1 1.6 7.5 2.09 10.18 2.06

IEI 3022 TT Not-rated 41.30 419 9.2 10.0 9.4 20.8 18.0 20.3 1.9 1.8 n.a. 32.1 -8.6 6.7 0.29 -1.16 1.41

Posiflex 8114 TT Not-rated 162.50 339 18.9 17.8 15.9 36.7 35.6 35.6 6.6 6.1 5.4 14.3 6.3 12.1 1.33 2.83 1.32

iBase 8050 TT Not-rated 56.80 200 14.7 12.8 12.0 18.3 19.1 20.8 2.6 2.5 2.2 48.0 14.8 6.7 0.31 0.86 1.79

Axiomtek 3088 TT Not-rated 76.30 186 16.1 14.2 12.9 25.3 26.1 25.1 3.8 3.6 3.2 36.9 13.3 10.2 0.44 1.07 1.26

Global IPC plays

Kontron KBC GR Not-rated 3.00 188 27.3 54.5 18.9 -2.5 0.2 1.9 0.7 0.7 0.6 n.a. -50.0 189.1 n.a. -1.09 0.10

Radisys RSYS US Not-rated 4.04 150 n.a. 100.0 16.2 -34.7 -20.4 n.a. 1.9 2.3 n.a. n.a. n.a. 518.5 n.a. n.a. 0.03

Taiwan automation plays

Delta* 2308 TT Outperform 145.50 11,674 17.1 20.2 19.4 21.1 16.8 14.6 3.4 3.1 2.6 17.2 -15.2 3.9 0.99 -1.33 4.96

Hiwin* 2049 TT Underperform 156.00 1,298 17.0 23.4 23.5 19.9 13.4 12.8 3.2 3.0 3.0 15.5 -27.5 -0.5 1.09 -0.85 -48.35

Airtac* 1590 TT Underperform 187.00 1,034 18.0 24.4 18.5 18.8 14.6 20.2 3.2 3.7 3.7 3.5 -26.1 31.4 5.08 -0.93 0.59

Taiwan cloud computing plays

Quanta* 2382 TT Outperform 59.20 7,063 12.1 12.5 12.4 14.8 14.5 15.0 1.7 1.9 1.8 -16.4 -3.2 0.5 -0.74 -3.91 24.61

Voltronic* 6409 TT Outperform 503.00 1,155 35.8 26.4 20.6 37.0 37.9 41.1 10.5 9.2 7.8 41.9 35.6 28.2 0.86 0.74 0.73

King Slide 2059 TT Not-rated 381.00 1,121 20.1 18.9 18.1 28.0 25.5 22.9 5.2 4.5 3.9 27.5 6.3 4.5 0.73 2.99 4.06

MiTAC 3706 TT Not-rated 26.40 634 25.6 11.8 10.7 2.4 5.0 5.2 0.6 0.6 0.5 32.1 116.8 10.8 0.80 0.10 0.98

AIC 3693 TT Not-rated 95.60 114 10.0 10.8 9.9 22.9 19.9 19.8 2.2 2.0 1.7 13.5 -6.9 9.2 0.75 -1.56 1.07

Source: Bloomberg, *Daiwa forecasts (market data as of 21 March 2016 unless otherwise stated)

0

2

4

6

8

10


(USDbn)

Market Cap 8x 12x

17x 21x 25x

0

2

4

6

8

10


Market Cap 1x 2.5x3.5x 4.5x 5.5x

(USDbn)

We see a number of

catalysts that should

support the sector’s

valuations

17


Strong ROEs seen supporting valuation premium

After conducting a valuation comparison across several industrial-related segments in

Taiwan (see table, previous page) – including IPC, automation, and cloud-computing

related plays – we note that Taiwan’s IPC sector as a whole delivers consistently better

ROEs than other segments, which are apt to show more volatility in ROEs.

In our view, the sector’s consistent earnings quality argues for a valuation premium over

the PC/handset hardware sectors in PBR terms. Also, we believe the sector’s existing

valuation premium underlines its relative defensiveness in the technology hardware space

amid lingering macro uncertainties.

Industrial PC sector: PBR-ROE (2015) Industrial PC sector: PBR-ROE (2016E)



Stock recommendations

Ennoconn (6414 TT, TWD384.0, Buy [1]; TP: TWD481.0)

We initiate coverage of Ennoconn with a Buy (1) rating. Our 12-month price target is set at

TWD481, based on a target PER of 26x (the peak of the stock’s past-3-year trading range

of 8-26x) applied to our 2016E EPS forecast. We believe the company has strong earnings

growth prospects, thanks to solid manufacturing and logistics support from its parent, Hon

Hai group, its focus on ODM business, and revenue contributions and potential synergies

associated with its active M&A strategy. On our forecasts, the company should deliver

stronger net earnings growth (49%/45% YoY for 2016E/2017E, respectively) and superior

ROEs (35%/38% for 2016E/2017E) than Advantech and Adlink, which should support its

valuation. Our TP for Ennoconn implies a PEG of 0.5x and is equivalent to 18x 2017E

PER, which we consider to be undemanding if, as we expect, synergies from the

company’s prior M&A activities start to come through in 2017.

Advantech (2395 TT, TWD235.0, Outperform [2]; TP: TWD254.0)

We upgrade Advantech to Outperform (2), from Hold (3), and raise our 12-month price

target to TWD254 (from TWD212), based on a target PER of 26x (ie, the mean of the

stock’s past-3-year trading range of 16x-32x; vs. previous target PER of 22x) applied to our

revised 2016E EPS. We raise our target PER as we expect strong earnings growth to

resume in 2016E following a relatively muted 2015 (EPS up only 4% YoY). Advantech is

the largest IPC company worldwide in terms of revenue, and we believe its industry

leadership means it is well positioned for the Industrial IoT trend. On the M&A front, the

company’s acquisition of B+B SmartWorx (announced in November 2015; effective from

January 2016) is likely to lead to higher opex in 1H16E but heralds promising synergies in

the Industrial IoT-related arena from 2017E onward, in our view.

Adlink (6166 TT, TWD76.0, Underperform [4]; TP: TWD68.0)

We initiate coverage of Adlink with an Underperform (4) rating. Our 12-month price target is

set at TWD68, based on a target PER of 22x (ie, the mean of the stock’s past-3-year

trading range of 12-40x) applied to our 2016E EPS forecast. Adlink is the third-largest IPC

Advantech

Ennoconn

Adlink Flytech

Posiflex

iBase

Axiomtek Delta Hiwin

Airtac

Quanta

Voltronic

King Slide

MiTAC

AIC

0

1

2

3

4

5

6

7

8

9

10

5 10 15 20 25 30 35 40

P/B

(x)

ROE (%)

Advantech Ennoconn

Delta

Flytech

Posiflex

iBase

Axiomtek Adlink Hiwin Airtac

Quanta

Voltronic

Kingslide

MiTAC

AIC

0

1

2

3

4

5

6

7

8

5 10 15 20 25 30 35 40 45

P/B

(x)

ROE (%)

Ennoconn is our top

pick in the Taiwan IPC

sector

We like Advantech for its

market leadership

18


company in Taiwan by revenue, with a particular strength in measurement- and

automation-related IPC products. In our view, lacklustre demand for IA products

(accounting for 35-40% of Adlink’s revenue, on our forecasts) remains a concern given the

ongoing macro uncertainties. Also, we believe the company’s operating margin could

weaken in 1H16 due to higher opex associated with its employee stock plan and the

acquisition of Prism Tech (announced in December 2015). As the market is still looking for

a stable operating-margin trend, we see a downside risk to the street’s earnings forecasts.

Finally, the stock’s weaker earnings growth (2% YoY in 2016E) and lower ROE (14% in

2016E) also argue for a discounted valuation relative to its peers, in our view.

Risks to our view

Downside risks to our Positive view on the Taiwan IPC sector include:

Worse-than-expected macro picture

Macro uncertainties have been a concern for some time, and should the situation

deteriorate by the more than we expect, IPC clients could choose to delay or suspend

capex projects related to facilities upgrades or IIoT implementation. In addition, currency

volatility in certain regions, such as the Eurozone and some emerging markets (eg, China),

could have an adverse earnings impact on IPC companies, particularly those which focus

on own-brand business.

M&A execution

Since all 3 IPC companies under our coverage have engaged in major M&A activities in

recent months, unexpected issues in their M&A-related execution could lead to prolonged

opex hikes or the realisation of weaker-than-expected synergies in the long run. Such

issues could have negative implications for our earnings forecasts for the 3 stocks.



Investment case: We initiate coverage of Ennoconn, the 2nd-largest IPC

player in Taiwan in terms of revenue, with a Buy (1) rating. We consider the

stock our top pick in the Taiwan IPC sector, in light of its strong earnings

growth outlook for 2016-17 and superior ROE vs. its domestic peers.

Benefits from strong ties with Hon Hai. As a member of the Hon Hai

group, Ennoconn benefits by leveraging on Hon Hai’s strong manufacturing

capabilities, which substantially help in improving Ennoconn’s cost-

competitiveness and flexibility. Also, Hon Hai’s steady implementation of

production automation makes it a potential client for Ennoconn.

Clear ODM focus bodes well for revenue growth. Compared to most

IPC players’ own-brand focus, Ennoconn’s clear ODM focus gives it a

larger addressable client base, which can include its peers in the IPC

sector (eg, Kontron), and better flexibility when entering new segments. We

believe this strategy will help Ennoconn achieve stronger revenue growth

than its peers along with favourable operating leverage going forward.

M&A an effective catalyst. Ennoconn has been more aggressive than its

peers on M&A, engaging in several deals of late, most recently its January

2016 announcement to acquire 49% of Kontron Canada Inc (KCI), which

should boost its telecom/networking-related revenue from 2Q16.

Financial outlook. We expect Ennoconn’s revenue for both 2016-17 to

beat management’s growth target of 30% YoY, driven by its telecom/

networking and networking securities businesses. In the near term, the

acquisition of KCI may lead to higher opex, but we expect the improving

operating leverage to offset this impact from 2Q16 onwards.

Catalysts: We expect Ennoconn’s strong revenue and earnings growth in

2017E, as well as further M&A activity down the road to be the major

catalysts for its share price.

Valuation: Our 12-month TP of TWD481 is based on a 2016E target PER

of 26x (the peak of the past 3-year trading range of 8-26x). We deem our

TP as undemanding, as it implies a PEG of 0.5x. We expect the stock’s

favourable valuation to be justified by strong EPS growth (49%/45% for

2016E/2017E) and superior ROE (35%/38% for 2016E/2017E), both above

those of peers Advantech (2395 TT, TWD235, Outperform [2]) and Adlink

(6166 TT, TWD76, Underperform [4]).

Risks: The key risks to our view: 1) worse-than-expected macro outlook,

and 2) a worse-than-expected financial impact from M&A integration.

23 March 2016

Ennoconn

Initiation: marching ahead

Strong support from the Hon Hai group is a major advantage

Clear ODM focus and proactive M&A strategy to fuel strong growth

Initiating with a Buy (1) rating and 12-month target price of TWD481

Source: FactSet, Daiwa forecasts

Ennoconn (6414 TT)

Target price: TWD481.00

Share price (21 Mar): TWD384.00 | Up/downside: +25.3%

Steven Tseng(886) 2 8758 6252

[email protected]

Jack Lin(886) 2 8758 6253

[email protected]

90

108

125

143

160

220

265

310

355

400

Mar-15 Jun-15 Sep-15 Dec-15

Share price performance

Ennoconn (LHS)Relative to TWSE Index (RHS)

(TWD) (%)

12-month range 234.50-395.50

Market cap (USDbn) 0.82

3m avg daily turnover (USDm) 7.53

Shares outstanding (m) 70

Major shareholder Pao Hsin Int'l Investment (39.0%)

Financial summary (TWD)

Year to 31 Dec 15E 16E 17E

Revenue (m) 11,057 15,971 21,156

Operating profit (m) 1,187 1,802 2,593

Net profit (m) 866 1,291 1,872

Core EPS (fully-diluted) 12.415 18.514 26.841

EPS change (%) 51.7 49.1 45.0

Daiwa vs Cons. EPS (%) (1.9) 6.7 2.3

PER (x) 30.9 20.7 14.3

Dividend yield (%) 1.6 2.3 3.2

DPS 6.0 9.0 12.1

PBR (x) 8.5 6.3 4.7

EV/EBITDA (x) 20.6 14.8 10.2

ROE (%) 31.0 35.0 37.8

20

Ennoconn (6414 TT): 23 March 2016



Growth outlook Ennoconn: revenue and earnings growth forecasts

We expect Ennoconn’s revenue and earnings to outgrow

that of other major Taiwanese IPC companies, such as

Advantech and Adlink, for both 2016E and 2017E, on

increasing outsourcing from its ODM clients (eg, Kontron

and Radisys), strong cost-competitiveness due to the

manufacturing support from Hon Hai group, and the

potential revenue contribution from further M&A deals.

Source: Company, Daiwa forecasts

Valuation Ennoconn: 1-year forward PER bands

We initiate coverage with a 12-month target price of

TWD481, based on a target PER of 26x (the peak of

stock’s past 3-year trading range of 8-26x) applied to our

2016E EPS. Compared to its Taiwan IPC peers, our target

PER for Ennoconn is the same as that for Advantech (26x)

but above that of Adlink (22x). We believe the favourable

valuation premium is justified by the company’s stronger

earnings growth, superior ROE and potential share-price

catalysts from further M&A activity.

Source: TEJ, Daiwa forecasts

Earnings revisions Ennoconn: Bloomberg consensus 2015-16E EPS revisions

The Bloomberg-consensus forecasts for Ennoconn have

declined moderately since mid-2015 due to rising macro

concerns. However, the consensus still seems to be

positive on the earnings growth for 2016E, given the

company’s solid organic revenue strength and potential

contributions from M&A deals, which management expects

to increase in 2016. As such, we look forward to likely

upward revisions to the company’s consensus earnings

forecasts down the road.

Source: Bloomberg

0%

20%

40%

60%

80%

100%

120%

140%

0

5

10

15

20

25

2013 2014 2015 2016E 2017E

Revenue (LHS) Net Income (LHS)

Revenue YoY (RHS) Net Income YoY (RHS)

(TWDbn)

0

100

200

300

400

500

Dec-12 May-13 Oct-13 Mar-14 Aug-14 Jan-15 Jun-15 Nov-15 Apr-16

(TWD)

Share price 8x 14x 21x 26x

0

5

10

15

20

Mar

-14

May

-14

Jul-1

4

Sep

-14

Nov

-14

Jan-

15

Mar

-15

May

-15

Jul-1

5

Sep

-15

Nov

-15

Jan-

16

2015 2016E

(TWD)

21


Financial summary

Key assumptions

Profit and loss (TWDm)

Cash flow (TWDm)


Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Telecom revenue YoY % n.a. n.a. n.a. n.a. n.a. 160.9 102.6 43.1

Network Securities revenue YoY % n.a. n.a. n.a. n.a. n.a. 1,069.2 32.0 36.0

ATM/POS revenue YoY % n.a. n.a. n.a. n.a. 18.4 2.1 4.7 7.0

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Telecom 0 0 0 0 1,314 3,428 6,943 9,937

Network Securities 0 0 0 0 303 3,544 4,680 6,366

Other Revenue 1,809 1,401 2,269 3,096 3,435 4,085 4,348 4,854

Total Revenue 1,809 1,401 2,269 3,096 5,052 11,057 15,971 21,156

Other income 0 0 0 0 0 0 0 0

COGS (1,503) (1,176) (1,856) (2,433) (4,110) (9,040) (13,047) (17,218)

SG&A 0 (74) (134) (150) (183) (501) (687) (803)

Other op.expenses 0 (65) (87) (102) (137) (329) (435) (542)

Operating profit 306 86 192 411 622 1,187 1,802 2,593

Net-interest inc./(exp.) 5 7 6 9 7 (1) (7) (13)

Assoc/forex/extraord./others 0 18 10 31 75 124 108 81

Pre-tax profit 311 112 208 450 704 1,310 1,904 2,661

Tax (28) (10) (34) (78) (122) (234) (343) (479)

Min. int./pref. div./others 0 0 0 0 (20) (210) (270) (311)

Net profit (reported) 284 102 174 372 562 866 1,291 1,872

Net profit (adjusted) 284 102 174 372 562 866 1,291 1,872

EPS (reported)(TWD) 6.144 2.152 3.224 6.151 8.185 12.415 18.514 26.841

EPS (adjusted)(TWD) 6.144 2.152 3.224 6.151 8.185 12.415 18.514 26.841

EPS (adjusted fully-diluted)(TWD) 6.144 2.152 3.224 6.151 8.185 12.415 18.514 26.841

DPS (TWD) 0.930 2.160 1.739 1.736 5.503 6.000 9.000 12.099

EBIT 306 86 192 411 622 1,187 1,802 2,593

EBITDA 313 95 204 427 637 1,288 1,917 2,742

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Profit before tax 311 112 208 450 704 1,310 1,904 2,661

Depreciation and amortisation 6 8 12 16 15 101 114 149

Tax paid (28) (10) (34) (78) (122) (234) (343) (479)

Change in working capital 16 33 (157) (94) (1,417) (5) (611) (603)

Other operational CF items 49 (13) 52 111 825 166 103 102

Cash flow from operations 356 130 80 405 5 1,338 1,167 1,831

Capex (13) (1) (2) (19) (167) (419) (2,319) (529)

Net (acquisitions)/disposals 0 0 (17) (254) 597 (221) (50) (50)

Other investing CF items (1) (1) (34) 2 (43) 39 0 0

Cash flow from investing (13) (2) (54) (271) 388 (601) (2,369) (579)

Change in debt 0 0 21 (15) (6) 994 2,000 0

Net share issues/(repurchases) 0 0 125 0 778 0 0 0

Dividends paid (39) (100) (82) (94) (333) (412) (628) (844)

Other financing CF items 1 0 0 (0) (155) (110) 0 0

Cash flow from financing (38) (100) 64 (109) 285 473 1,372 (844)

Forex effect/others 0 0 (1) 1 3 (1) 0 0

Change in cash 305 28 89 27 680 1,209 170 409

Free cash flow 343 129 78 386 (162) 918 (1,152) 1,302

22


Financial summary continued …

Balance sheet (TWDm)

Key ratios (%)


As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Cash & short-term investment 607 635 724 1,033 931 2,245 2,415 2,824

Inventory 55 104 105 225 992 1,309 1,644 2,146

Accounts receivable 221 208 591 507 2,019 2,531 3,238 4,231

Other current assets 7 12 60 6 38 90 90 90

Total current assets 889 960 1,479 1,771 3,979 6,175 7,388 9,292

Fixed assets 18 7 11 26 50 592 2,797 3,177

Goodwill & intangibles 0 0 0 0 0 0 0 0

Other non-current assets 3 7 12 11 1,208 1,028 1,095 1,162

Total assets 910 975 1,502 1,808 5,237 7,796 11,279 13,630

Short-term debt 0 0 21 6 0 200 200 200

Accounts payable 217 300 549 515 1,388 2,214 2,645 3,538

Other current liabilities 33 11 43 99 255 439 439 439

Total current liabilities 250 311 613 620 1,644 2,853 3,284 4,177

Long-term debt 0 0 0 0 0 477 2,477 2,477

Other non-current liabilities 2 2 3 2 8 3 3 3

Total liabilities 252 313 616 622 1,652 3,334 5,765 6,658

Share capital 462 474 539 605 687 697 697 697

Reserves/R.E./others 196 188 347 581 1,728 2,470 3,523 4,980

Shareholders' equity 658 662 886 1,186 2,415 3,167 4,220 5,678

Minority interests 0 0 0 0 1,170 1,295 1,295 1,295

Total equity & liabilities 910 975 1,502 1,808 5,237 7,796 11,279 13,630

EV 26,169 26,141 26,073 25,748 27,016 26,503 28,333 27,924

Net debt/(cash) (607) (635) (703) (1,027) (931) (1,568) 262 (147)

BVPS (TWD) 14.242 13.957 16.425 19.617 35.162 45.422 60.517 81.424

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Sales (YoY) 60.1 (22.6) 61.9 36.5 63.2 118.9 44.4 32.5

EBITDA (YoY) 30.2 (69.8) 115.4 109.7 49.1 102.3 48.8 43.1

Operating profit (YoY) 29.8 (71.8) 122.4 113.8 51.5 90.8 51.8 43.9

Net profit (YoY) 27.1 (64.0) 70.4 113.8 51.2 54.0 49.1 45.0

Core EPS (fully-diluted) (YoY) 14.7 (65.0) 49.8 90.8 33.1 51.7 49.1 45.0

Gross-profit margin 16.9 16.1 18.2 21.4 18.6 18.2 18.3 18.6

EBITDA margin 17.3 6.7 9.0 13.8 12.6 11.6 12.0 13.0

Operating-profit margin 16.9 6.2 8.5 13.3 12.3 10.7 11.3 12.3

Net profit margin 15.7 7.3 7.7 12.0 11.1 7.8 8.1 8.8

ROAE 46.4 15.5 22.5 35.9 31.2 31.0 35.0 37.8

ROAA 33.4 10.8 14.0 22.5 16.0 13.3 13.5 15.0

ROCE 50.1 13.1 24.5 39.1 26.0 27.2 27.0 29.1

ROIC 365.2 203.7 153.7 198.9 36.6 35.1 34.1 33.7

Net debt to equity n.a. n.a. n.a. n.a. n.a. n.a. 6.2 n.a.

Effective tax rate 8.9 8.8 16.3 17.4 17.3 17.9 18.0 18.0

Accounts receivable (days) 42.3 55.9 64.3 64.7 91.2 75.1 65.9 64.4

Current ratio (x) 3.6 3.1 2.4 2.9 2.4 2.2 2.2 2.2

Net interest cover (x) n.a. n.a. n.a. n.a. n.a. 1,518.0 262.7 196.2

Net dividend payout 15.1 100.4 53.9 28.2 67.2 48.3 48.6 45.1

Free cash flow yield 1.3 0.5 0.3 1.4 n.a. 3.4 n.a. 4.9

Company profile

Established in 1999 and listed in 2014, Ennoconn Corp. (Ennoconn) is a leading industrial PC (IPC)

manufacturer, 41%-held by Hon Hai. The company provides total hardware system solutions to

various vertical market applications (POS, banking automation, kiosks, lotteries and industrial

automation) on the ODM basis. With extensive professional knowledge, Ennoconn aims to deliver

state-of-the-art technology of a high quality and at speed to its clients. The company also adopts an

aggressive M&A strategy to facilitate its entry into different vertical application areas.

23


Company background

Ennoconn – Hon Hai’s proxy in the IPC sector

Founded in 1999, Ennoconn began with designing industrial motherboards, and

subsequently started penetrating the IPC space, focusing particularly on vertical

applications such as points of sale (POS), banking automation, kiosks, lotteries, industrial

automation, etc. Hon Hai group has been the largest shareholder of Ennoconn since 2007

and currently owns a 41% stake through subsidiaries Pao-Hsin International Investment

and Yang Venture Investment. Unlike other IPC companies which tend to focus on own-

brand business, Ennoconn is a dedicated ODM player and is able to leverage on the

excellent manufacturing capabilities from Hon Hai group.

To enhance its reach in different vertical applications, Ennoconn has made a number of

acquisitions in recent years, including Nanjing Asiatek in 2012, Goldtek and Caswell in

2014, Taiwan Applied and Thecus in late 2015, and KCI in early 2016. It also set up 2 fully

owned subsidiaries during 2015, ie, EnnoMech Precision (for POS/ATM/Kiosk related

mechanical parts) and Sys-P (for POS).

Ennoconn: company organisation holding structure

Source: Company

Ennoconn: shareholder structure (as of February 2016) Ennoconn: revenue breakdown by region (as of 2014)

Source: Company, TEJ Source: Company Note: * Excluding Taiwan

Management Team, 1%

Hon Hai, 41%

Free Flow, 58%

Taiwan, 3%

Asia*, 35%

Amercias, 42%

Europe, 20%

Different from its peers,

Ennoconn is dedicated

to the ODM business,

with strong support from

parent Hon Hai group

24


Major businesses

Ennoconn has 5 major business lines, including:

Automated teller machines (ATMs): Ennoconn is a major ODM supplier to global

leading ATM players, such as NCR and Wincor Nixdorf (acquired by Diebold in

November 2015). While global ATM demand is generally stable, Ennoconn has been

benefiting from its key clients gaining market share and also upgrade demand along

with automation trends for banking services (ie, Bank 3.0).

Points of sale (POS): This is similar to the ATM business, as Ennoconn also acts as a

major ODM supplier to global leading POS players, such as Toshiba TEC, NCR, Wincor

Nixdorf (ie, Diebold), DigiPOS, etc. There are clear synergies between ATM and POS

businesses, since they share similar client bases and component supply chains.

Industrial automation (IA): We consider IA as one of Ennoconn’s major business areas

with good long-term potential, although the revenue growth in recent years has been

lacklustre due to the overall cautious trend on global capex. Kontron is a major client in

Ennoconn’s IA business, and we believe Hon Hai group could become another key

customer, due to its in-house demand for production automation.

Telecom/networking: We expect this segment as a key growth area for Ennoconn,

driven mainly by its outsourcing share gains in Radisys. In addition, the potential

revenue contribution from newly acquired KCI (announced in January 2016) should be

another growth driver from 2Q16 onwards.

Network security: This business is mainly contributed by Caswell (6416 TT, Not rated),

which is 38.7%-owned by Ennoconn and its financials were consolidated into Ennoconn

in December 2014. This business is also a key revenue contributor for Ennoconn and a

major revenue growth driver.

Ennoconn: revenue breakdown by major business lines


33%26%

12% 9% 7%

29%

19%

9%7% 5%

29%

12%

5%4% 3%

0%

26%

31% 43% 47%

0%6%

32%29% 30%

9% 11% 11% 8% 7%

0%

20%

40%

60%

80%

100%

2013 2014 2015 2016E 2017E

ATM POS IA Telecom Network Securities Other

25


Marching ahead

Benefiting from strong ties with Hon Hai

As a member of Hon Hai group, Ennoconn is essentially Hon Hai’s proxy in the IPC sector.

We believe the company’s strong ties with Hon Hai group are bringing the following

benefits.

Hon Hai as a key manufacturing partner

Given Hon Hai group’s superior manufacturing capability and existing capacities

worldwide, Ennoconn is able to focus on R&D and marketing for its IPC business and

outsource its manufacturing activities to Hon Hai. This substantially enhances Ennoconn’s

cost-competiveness and production flexibility. We believe Hon Hai also benefits from such

an outsourcing relationship as it can utilise some of the aged facilities which could have

been fully depreciated. Moreover, Hon Hai group’s well-known expertise in mechanical

components also helps Ennoconn win orders for ATM/POS-related mechanical parts,

which are handled by 100%-owned EnnoMech and could become another revenue stream

going forward.

By leveraging on the manufacturing support from Hon Hai group, Ennoconn is able to

enjoy an “asset-light” advantage, which should lead to higher asset turnover and superior

ROE to its major IPC peers over the next few years.

Asset turnover of Ennoconn, Advantech, and Adlink ROE of Ennoconn, Advantech, and Adlink

Source: TEJ, Daiwa forecasts Source: TEJ, Daiwa forecasts

Hon Hai as a promising IA customer

Being the largest EMS company in the world, Hon Hai has been planning to implement

automation/robotic facilities at its manufacturing sites to enhance production efficiency and

cope with rising labour costs in China. In fact, Hon Hai Group Chairman Mr. Terry Guo

vowed in early 2015 that Hon Hai would adopt IA for 70% of its product lines over the

following 3 years. Despite its very limited revenue contribution at the moment, Hon Hai

could become another important customer for Ennoconn’s IA business going forward, in

our view.

Clear ODM focus enables strong revenue growth

Broader addressable markets

While most IPC companies typically focus on their own-brand businesses (such as

Advantech and Kontron), Ennoconn is dedicated to ODM operations for several vertical

segments including ATMs, POS, IA, telecom/networking, etc. We believe such an ODM

focus suggests potentially broader addressable markets, for 2 reasons:

Likely broader client base

Ennoconn’s ODM customers can include players in different vertical segments (such as

NCR in the ATM/POS business) and even other IPC companies, as there is little by the

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2015 2016E 2017E

Ennoconn Advantech Adlink

0%

5%

10%

15%

20%

25%

30%

35%

40%

2015 2016E 2017E


By outsourcing to Hon

Hai group, Ennoconn is

able to enjoy an “asset-

light” advantage

Ennoconn’s ODM focus

gives it a broader client

base, and better

flexibility when moving

into a new application

area

26


way of conflict of interest. In fact, Ennoconn has been a major ODM supplier to both

Kontron and Radisys for years, and Ennoconn’s recent investment in Kontron Canada

suggests a deeper client relationship.

Likely better flexibility

Being a dedicated ODM player, Ennoconn is able to step into a new vertical segment faster

than its own-brand IPC peers, as its involvement with clients can be very flexible – for

instance, it can simply be a supplier for a specific project, or work more closely with the

client on broader product/service coverage, subject to its own capabilities and/or the

clients’ requirements. Such flexibility means Ennoconn can enjoy a faster time-to-market

should any potential opportunities arise.

Solid revenue growth helps operating leverage

Given its ODM business focus, Ennoconn’s gross margin is below those of Advantech and

Adlink. That said, the differences in their operating margins are noticeably narrower, since

Ennoconn’s stronger revenue growth helps to provide more favourable operating leverage

(see charts below). With the ongoing support from Hon Hai and Ennoconn’s sustained

revenue growth (partially supported by its M&A activity, which are detailed below), we

expect the improving trend of operating leverage to continue, further narrowing the gap

with operating margins over time.

Ennoconn: gross margin vs. peers Ennoconn: operating margin vs. peers


Effective catalysts from M&A activities

M&A a major growth catalyst

While M&A activities have been vibrant in the IPC sector for a few years now, Ennoconn

appears to be more aggressive than its peers recently. Moreover, management has been

vocal in its ambition in M&A and continues to seek suitable acquisition targets to accelerate

its diversification into various vertical applications. As shown in the table below, Ennoconn

has closed 6 acquisitions in the past 4 years, and the company remains proactive in

searching for potential targets for acquisition or with which to form strategic alliances.

Ennoconn: major M&A transactions in recent years

Time Acquirer Acquisition target Major business Deal value Post-Deal Holding Remark

Feb-12 Ennoconn AsiaTek Smart car-related products (eg, GPS/GPRS/CDMA) and intelligent transportation system (ITS)-related applications

n.a. 100% Becoming Ennoconn's HQ in China

Sep-14 Ennoconn GoldTek ODM & OEM for portable device customization n.a. 55% Maintaining "GOLDTek" brand

Oct-14 Ennoconn Caswell (6416 TT) Network storage server and security appliances mainly for network/communication sector

TWD953.1m 39% Maintaining "Casewel" brand

Nov-15 Ennoconn Taiwan Applied Smart cards and mobile banking related solutions n.a. 60%

Dec-15 Ennoconn Thecus Network storage and mobile cloud related solutions n.a. 60%

Jan-16 Ennoconn Kontron Canada Industrial computing products/solutions for communication segment USD57.3m 49%


For Ennoconn, M&A activities have become an important driver for its revenue and

earnings, aside from the organic growth of its existing businesses. For example, the

acquisition of Caswell (6416 TT, Not rated) in late 2014 essentially added a new business

0%

10%

20%

30%

40%

50%

1Q13

2Q13

3Q13

4Q13

1Q14

2Q14

3Q14

4Q14

1Q15

2Q15

3Q15

4Q15

1Q16

E

2Q16

E

3Q16

E

4Q16

E

1Q17

E

2Q17

E

3Q17

E

4Q17

E


0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

1Q13

2Q13

3Q13

4Q13

1Q14

2Q14

3Q14

4Q14

1Q15

2Q15

3Q15

4Q15

1Q16

E

2Q16

E

3Q16

E

4Q16

E

1Q17

E

2Q17

E

3Q17

E

4Q17

E


We expect Ennoconn to

be more aggressive in

terms of M&A than its

peers in 2016

27


line for Ennoconn (ie, network securities) and helped boost the revenue growth in 2015

(+119% YoY). In addition, Ennoconn is able to boost the cost-competiveness of the

acquired company by introducing Hon Hai’s manufacturing support, which helps to

expedite potential M&A synergies.

YoY revenue growth comparison of major Taiwan IPC companies


The most recent M&A deal – Kontron Canada Inc

Transaction overview

On 22 January 2016, Ennoconn announced plans to enter into a strategic partnership with

Kontron in the communications segment. Under this partnership, Ennoconn will take a 49%

stake in Kontron Canada Inc (KCI) at a price of USD57.3m (~TW1.93bn). The deal is

subject to regulatory and corporate approvals, which are expected to be granted in the first

half of 2016, and as such, the revenue generated by KCI may start to be consolidated into

Ennoconn as early as in 2Q16. To finance the deal, we expect the company to consider a

capital injection this year, although the details are yet to be finalised.

KCI is a 100%-owned subsidiary of Kontron which is dedicated to industrial computing

solutions for the communications sector. Despite being a profitable company, KCI has

been under pressure due to the general market demand shift away from hardware towards

so-called software-defined networking (SDN). The partnership of Ennoconn and KCI

should allow KCI to focus on its expertise in both hardware and software requirement for

the SDN market, while Ennoconn provides support in ODM capabilities and supply chain

efficiency. In the long run, Kontron also targets to establish a presence in the Asia-Pacific

region through the existing channel networks of Ennoconn and Hon Hai group.

Potential benefits

KCI’s annual revenue, according to Ennoconn, is about USD120m (~TWD3.4bn),

equivalent to around 31% of Ennoconn’s 2015 revenue. Assuming the transaction is

successful and becomes effective from 2Q16, we estimate KCI will boost Ennoconn’s

telecom/networking business line and contribute 10% to Ennoconn’s revenue in 2016E and

14% in 2017E. That said, considering Ennoconn’s ownership of KCI (post deal) of 49%,

and the likely initial impact on opex and M&A related amortisation, we expect the earnings

contribution to be 3-4% in 2016E and 5-7% in 2017E.

(50%)

0%

50%

100%

150%

200%

250%

1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16E 2Q16E 3Q16E 4Q16E 1Q17E 2Q17E 3Q17E 4Q17E


AsiaTek(Sep, '14)

CaswellTWD953m(Oct, '14)

Ennoconn’s latest

acquisition of Kontron

Canada should boost its

telecom/networking

business line

28


Valuation and recommendation

Financial update

We expect revenue growth to remain strong

We forecast Ennoconn’s revenue growth to reach 44% YoY for 2016E and 32% YoY for

2017E, driven mainly by telecom/networking (thanks to outsourced orders from Radisys

and the revenue contribution from the acquisition of KCI), network securities (thanks to

Caswell), and mechanical parts (thanks to EnnoMech, with shipments expected to start

from 2Q16).

As for other segments, ATM/POS should remain generally stable (around single-digit YoY

growth) while we expect demand for IA to remain lacklustre given the cautious global

capex outlook, although we do look forward to a likely recovery from 2H16 as the market

demand may start to bottom out. Overall, we see no major difficulty for the company to

beat management’s annual growth target of 30% YoY, based on their current business

momentum, not to mention the likely extra revenue contributions from more potential M&A

announcements down the road.

To finance the recent acquisitions and rising demand for working capital, Ennoconn plans

to raise TWD3bn via both convertible bonds (likely in April 2016) and a rights issue (likely

in July 2016). Furthermore, management does not rule out the possibility of another round

of fundraising in late 2016 should there be more acquisitions or equity investment projects

confirmed during the year.

Near-term margin pressure looks inevitable

We expect the acquisition of KCI to add potential pressure to the operating margin in

1H16, due to the likely higher opex associated with the M&A deal. That said, stronger

revenue growth (particularly from 2Q16 onwards) should support better operating leverage

and help to enhance the operating margin trend.

Ennoconn: quarterly and annual P&L statement

2015 2016

(TWDm) 1Q 2Q 3Q 4Q 1QE 2QE 3QE 4QE

2014 2015 2016E

Net revenue 2,386 2,613 2,798 3,259 3,115 3,815 4,471 4,570

5,052 11,057 15,971

COGS (1,954) (2,152) (2,294) (2,640) (2,548) (3,126) (3,644) (3,728)

(4,110) (9,040) (13,047)

Gross profit 432 461 504 619 567 688 827 842

942 2,017 2,924

Operating expenses (169) (172) (210) (279) (249) (282) (297) (293)

(320) (829) (1,121)

Operating profit 264 289 295 340 317 406 530 549

622 1,187 1,802

Non-operating profit (9) 11 96 25 38 30 17 17

82 123 101

Pre-tax profit 255 299 391 365 355 436 546 566

704 1,310 1,904

Income taxes (47) (55) (70) (63) (64) (78) (98) (102)

(122) (234) (343)

Net profit 174 203 247 242 231 297 375 388

562 866 1,291

Net EPS (TWD) 2.53 2.95 3.58 3.47 3.31 4.26 5.38 5.56

8.19 12.42 18.51

Operating Ratios

Gross margin 18.1% 17.6% 18.0% 19.0% 18.2% 18.0% 18.5% 18.4%

18.6% 18.2% 18.3%

Operating margin 11.0% 11.0% 10.5% 10.4% 10.2% 10.6% 11.8% 12.0%

12.3% 10.7% 11.3%

Pre-tax margin 10.7% 11.4% 14.0% 11.2% 11.4% 11.4% 12.2% 12.4%

13.9% 11.8% 11.9%

Net margin 7.3% 7.8% 8.8% 7.4% 7.4% 7.8% 8.4% 8.5%

11.1% 7.8% 8.1%

YoY (%)

Net revenue 245% 173% 115% 55% 31% 46% 60% 40%

63% 119% 44%

Gross profit 191% 128% 118% 72% 31% 49% 64% 36%

42% 114% 45%

Operating profit 213% 95% 89% 46% 20% 41% 80% 61%

52% 91% 52%

Pre-tax profit 160% 105% 124% 28% 39% 46% 40% 55%

56% 86% 45%

Net profit 114% 67% 70% 13% 33% 46% 52% 60%

51% 54% 49%

QoQ (%)

Net revenue 13% 10% 7% 16% -4% 22% 17% 2%

Gross profit 20% 7% 9% 23% -9% 21% 20% 2%

Operating profit 13% 10% 2% 16% -7% 28% 30% 4%

Pre-tax profit -11% 17% 31% -6% -3% 23% 25% 4%

Net profit -19% 17% 22% -2% -5% 29% 26% 3%


We expect Ennoconn’s

revenue strength to be

fuelled by the telecom,

network securities, and

mechanical parts related

businesses

29


Ennoconn: revenue and earnings forecasts and comparison vs. consensus

2015 2016E 2017E

(TWDm) Actual Consensus Forecast Consensus Forecast Consensus

Revenue 11,057 10,892 15,971 14,775 21,156 19,644

Diff (%) 1.5% 8.1% 7.7%

Gross Margin (%) 18.2% 17.9% 18.3% 18.4% 18.6% 18.6%

Operating profit 1,187 1,196 1,802 1,684 2,593 2,507

Op Margin (%) 10.7% 11.0% 11.3% 11.4% 12.3% 12.8%

Net profit 866 869 1,291 1,210 1,872 1,830

EPS (TWD) 12.6 12.7 18.5 17.4 26.8 26.2

Diff (%) -0.4% 6.7% 2.3%



Initiate with a Buy rating

We initiate coverage of Ennoconn with a Buy (1) rating. Our 12-month target price is set at

TWD481, based on a target PER of 26x (at the peak of the stock’s past 3-year trading

range of 8-26x) applied to our 2016E EPS. Compared with its Taiwan IPC peers, our target

PER for Ennoconn is the same as that for Advantech (26x) but above that of Adlink (22x).

We believe the favourable valuation premium can be justified by Ennoconn’s stronger

earnings growth, superior ROE, and potential catalysts from its upcoming M&A activities. In

fact, our target price implies a PEG of 0.5x and 18x 2017E PER, which look undemanding

if the potential synergies from the company’s acquisitions start to emerge from 2017E

onwards as we expect.

Ennoconn: 1-year-forward PER bands Ennoconn: 1-year-forward PBR bands


Catalysts and risks

The catalysts we see for Ennoconn’s share price include:

Strong revenue/earnings momentum in terms of both organic growth and contribution

from M&A.

Further M&A deals.

The key downside risks to our positive view on the stock are:

A higher-than-expected opex impact from M&A integration, which would mean the

integration benefits from KCI would be lower than we expected.

A worse-than-expected global economy, which would put pressure on our revenue

forecasts for Ennoconn.

0

100

200

300

400

500


(TWD)


0

100

200

300

400

500


(TWD)

Share price 2x 3x 4x 5.5x



What's new: We have turned more positive on Advantech’s growth

outlook, due mainly to the strength of its industrial IoT-related businesses.

We think the acquisition of B+B SmartWorx could lead to near-term

operating margin pressures, but are positive on the promising synergies in

the long run. This note marks a transfer of coverage to Steven Tseng.

What's the impact: Industrial IoT – the key growth theme. We believe

Advantech, the world’s largest industrial PC (IPC) company, is in a strong

position to benefit from the rising trend of industrial IoT. In 2016, we expect

the company’s intelligent systems for infrastructure, transportation and

energy segments to be its major demand drivers. Meanwhile, we see its

industrial automation (IA) business being supported by production facility

upgrade demand, but macro uncertainties could remain a drag.

B+B SmartWorx likely to have a mixed impact. According to

management, Advantech’s acquisition of B+B SmartWorx (an unlisted US

company specialising in providing IoT-related connectivity solutions; deal

announced in November 2015) should help strengthen Advantech’s IoT

capability, with the revenue contribution likely to kick in from 1Q16.

However, we expect some near-term pressure on operating margins, due

to higher opex from the acquisition.

Earnings revisions. We are raising our 2015-17E EPS by 2.6-6.1%,

mainly to reflect: 1) the additional revenue contribution from B+B

SmartWorx, and 2) a likely operating margin recovery in 2H16 on improving

operating leverage, following a potential margin drag in 1H16 due to the

acquisition. We expect its operating margin to recover in 2H16 on

improving operating leverage and preliminary synergies from the deal.

What we recommend: We upgrade our rating on Advantech to Outperform

(2) from Hold (3) and raise our 12-month target price to TWD254 (from

TWD212), based on a higher 2016E target PER of 26x (ie, the mean of the

past-3-year PER range of 16-32x; vs. 22x previously). We are raising our

target PER as we expect Advantech to resume strong earnings growth from

2016E onwards, following the relatively muted 2015 (with net profit up just

4% YoY), and look forward to potential synergies in its industrial IoT related

businesses from B+B SmartWorx, following the initial opex pressure. The

key downside risks to our call: a worse-than-expected macro situation and

slower-than-expected M&A integration.

How we differ: Our 2017E EPS is 10.9% above the Bloomberg-consensus

forecast, as we are more positive on the potential synergies from the

acquisition of B+B SmartWorx.

23 March 2016

Advantech

Upgrading: strong earnings to resume from 2016E

Well-positioned to benefit from the rising industrial IoT business

Positive synergies on B+B SmartWorx, albeit near-term opex drag

Upgrading to Outperform (2); raising target price to TWD254

Source: Daiwa forecasts


Advantech (2395 TT)

Target price: TWD254.00 (from TWD212.00)

Share price (21 Mar): TWD235.00 | Up/downside: +8.0%

Steven Tseng(886) 2 8758 6252

[email protected]

Jack Lin(886) 2 8758 6253

[email protected]

Forecast revisions (%)


Revenue change - 4.0 6.3

Net profit change 2.6 2.8 6.1

Core EPS (FD) change 2.6 2.8 6.1

75

83

90

98

105

190

211

233

254

275



Advantech (LHS)Relative to TWSE Index (RHS)

(TWD) (%)

12-month range 194.50-275.00




Major shareholder AsusTek Computer Inc. (14.2%)



Revenue (m) 38,001 45,439 53,245

Operating profit (m) 5,929 7,029 8,683

Net profit (m) 5,104 6,173 7,443


EPS change (%) 3.9 20.9 20.6

Daiwa vs Cons. EPS (%) (0.4) 5.7 10.9

PER (x) 29.1 24.1 20.0


DPS 6.0 6.2 7.5

PBR (x) 6.4 5.7 5.1

EV/EBITDA (x) 21.7 18.7 15.1

ROE (%) 22.4 25.0 26.9

31

Advantech (2395 TT): 23 March 2016



Growth outlook Advantech: revenue and earnings growth forecasts

We raise our 2015-17E EPS by 2.6-6.1%, respectively,

mainly to reflect: 1) the additional revenue contribution

from the newly acquired B+B SmartWorx, and 2) a likely

operating margin recovery in 2H16 on improving operating

leverage, following a potential margin drag in 1H16 due to

the B+B SmartWorx acquisition. Our revised 2017E EPS is

10.9% above the Bloomberg-consensus forecast, as we

are more positive on the potential synergies from the

acquisition of B+B SmartWorx.


Valuation Advantech: 1-year forward PER bands

We upgrade Advantech to Outperform (2) from Hold (3)

and raise our 12-month TP to TWD254 (from TWD212),

based on a higher target PER of 26x (ie, the mean of the

stock’s past-3-year PER range of 16-32x; vs. the previous

target PER of 22x) applied to our 2016E EPS. We expect

the favourable growth of Advantech’s industrial IoT

businesses and potential synergies from B+B SmartWorx

to be effective share-price catalysts down the road.


Earnings revisions Advantech: Bloomberg-consensus 2015-16E revisions

The Bloomberg-consensus forecasts for Advantech have

been declining moderately since mid-2015, due likely to

investors’ general concerns about the weaker macro

outlook in 2016E and Advantech’s weaker operating

margin in 3Q15. Looking ahead, we still expect upwards

earnings revisions by the street, on the strong growth

momentum in its IoT related businesses (including B+B

SmartWorx) and potential operating margin recovery in

2H16.

Source: Bloomberg

0%

5%

10%

15%

20%

25%

0

10

20

30

40

50

60

2013 2014 2015 2016E 2017E



(TWDbn)

0

50

100

150

200

250

300

Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16


(TWD)

0

2

4

6

8

10

12

Apr

-13

Jun-

13

Aug

-13

Oct

-13

Dec

-13

Feb

-14

Apr

-14

Jun-

14

Aug

-14

Oct

-14

Dec

-14

Feb

-15

Apr

-15

Jun-

15

Aug

-15

Oct

-15

Dec

-15

Feb

-16

2015 2016E

(TWD)

32


Financial summary

Key assumptions


Cash flow (TWDm)


Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Embedded Design-in sales YoY% n.a. n.a. n.a. 18.7 19.6 9.4 22.0 16.0

Industrial IoT sales YoY% n.a. n.a. n.a. 4.1 27.2 0.2 26.1 25.6

Smart City Solutions sales YoY% n.a. n.a. n.a. 25.2 0.4 4.8 (0.2) 17.7

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Embedded Design-in n.a. n.a. 12,398 14,717 17,605 19,256 23,485 27,250

Industrial IoT n.a. n.a. 8,541 8,891 11,312 11,332 14,290 17,949

Other Revenue n.a. n.a. 6,612 7,052 6,815 7,412 7,664 8,046

Total Revenue 23,031 26,434 27,552 30,660 35,732 38,001 45,439 53,245

Other income 0 0 0 0 0 0 0 0

COGS (13,818) (15,909) (16,628) (18,074) (21,339) (22,656) (26,899) (31,377)

SG&A (3,681) (4,229) (4,660) (5,157) (5,649) (5,873) (7,289) (8,345)

Other op.expenses (2,060) (2,269) (2,406) (2,761) (3,235) (3,544) (4,221) (4,839)

Operating profit 3,472 4,027 3,858 4,668 5,508 5,929 7,029 8,683

Net-interest inc./(exp.) 4 (9) 4 24 40 31 25 24

Assoc/forex/extraord./others 181 326 369 481 507 330 462 350

Pre-tax profit 3,657 4,344 4,232 5,210 6,055 6,290 7,517 9,057

Tax (589) (773) (746) (1,041) (1,123) (1,163) (1,315) (1,585)

Min. int./pref. div./others (28) (18) (23) (21) (24) (23) (29) (30)

Net profit (reported) 3,039 3,553 3,462 4,149 4,908 5,104 6,173 7,443

Net profit (adjusted) 3,039 3,553 3,462 4,149 4,908 5,104 6,173 7,443

EPS (reported)(TWD) 6.059 6.438 6.139 7.286 7.775 8.078 9.769 11.778

EPS (adjusted)(TWD) 6.059 6.438 6.139 7.286 7.775 8.078 9.769 11.778


DPS (TWD) 3.888 3.500 5.011 4.900 0.000 6.000 6.234 7.538

EBIT 3,472 4,027 3,858 4,668 5,508 5,929 7,029 8,683

EBITDA 3,881 4,513 4,306 5,152 6,106 6,595 7,740 9,586

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Profit before tax 3,657 4,344 4,232 5,210 6,055 6,290 7,517 9,057


Tax paid (589) (773) (746) (1,041) (1,123) (1,163) (1,315) (1,585)

Change in working capital (2,081) (887) 226 (614) (915) (538) (532) (991)

Other operational CF items 884 756 85 960 296 649 35 32

Cash flow from operations 2,280 3,926 4,244 4,999 4,911 5,904 6,415 7,416

Capex (259) (2,210) (621) (1,634) (1,234) (1,351) (3,862) (1,597)

Net (acquisitions)/disposals (784) (62) (162) (62) (17) (2,278) (655) (775)

Other investing CF items 180 (771) 217 (188) (465) 1,986 0 0

Cash flow from investing (862) (3,043) (566) (1,884) (1,717) (1,643) (4,518) (2,372)

Change in debt (8) 923 (30) 71 (182) 878 0 0


Dividends paid (2,007) (1,756) (2,765) (2,764) (3,018) (3,787) (3,939) (4,763)

Other financing CF items (74) 19 166 (197) 290 (88) 143 136

Cash flow from financing (2,089) (813) (2,629) (2,889) (2,910) (2,998) (3,796) (4,628)

Forex effect/others (194) 165 (156) 193 36 (26) 0 0

Change in cash (865) 235 893 419 321 1,236 (1,899) 416

Free cash flow 2,022 1,717 3,623 3,365 3,677 4,553 2,553 5,818

33




Key ratios (%)


As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Cash & short-term investment 2,351 3,454 4,970 5,516 6,724 6,294 4,395 4,811

Inventory 3,531 3,895 3,890 4,031 4,782 4,869 5,868 6,720

Accounts receivable 3,391 3,861 4,281 5,383 5,952 6,467 7,127 8,472


Total current assets 9,692 11,452 13,785 15,412 17,990 18,086 17,847 20,460

Fixed assets 4,175 6,139 6,333 7,942 8,877 9,577 12,728 13,423


Other non-current assets 4,369 3,985 3,906 4,183 4,677 6,317 7,307 8,361

Total assets 18,236 21,576 24,024 27,536 31,544 33,979 37,882 42,244

Short-term debt 39 171 151 123 3 881 881 881

Accounts payable 3,201 3,536 4,486 4,993 5,736 5,637 6,764 7,970

Other current liabilities 890 851 830 2,089 2,115 2,725 2,725 2,725

Total current liabilities 4,130 4,559 5,467 7,205 7,854 9,243 10,370 11,576

Long-term debt 20 771 187 103 43 0 0 0

Other non-current liabilities 459 551 560 808 1,109 1,283 1,283 1,283

Total liabilities 4,608 5,882 6,214 8,116 9,006 10,525 11,652 12,859

Share capital 5,016 5,518 5,640 5,669 6,301 6,319 6,319 6,319

Reserves/R.E./others 8,517 10,076 12,062 13,589 16,050 16,989 19,764 22,920

Shareholders' equity 13,533 15,594 17,702 19,258 22,351 23,308 26,083 29,239

Minority interests 94 100 108 162 187 146 146 146

Total equity & liabilities 18,236 21,576 24,024 27,536 31,544 33,979 37,882 42,244

EV 146,293 146,080 143,968 143,363 142,000 143,225 145,123 144,707

Net debt/(cash) (2,293) (2,511) (4,631) (5,291) (6,678) (5,413) (3,514) (3,930)

BVPS (TWD) 26.979 28.261 31.387 33.822 35.410 36.886 41.278 46.274

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Sales (YoY) 50.3 14.8 4.2 11.3 16.5 6.3 19.6 17.2

EBITDA (YoY) 80.8 16.3 (4.6) 19.7 18.5 8.0 17.4 23.8

Operating profit (YoY) 92.8 16.0 (4.2) 21.0 18.0 7.6 18.6 23.5

Net profit (YoY) 73.5 16.9 (2.5) 19.8 18.3 4.0 20.9 20.6

Core EPS (fully-diluted) (YoY) 78.6 6.3 (4.7) 18.7 6.7 3.9 20.9 20.6


EBITDA margin 16.9 17.1 15.6 16.8 17.1 17.4 17.0 18.0



ROAE 22.9 24.4 20.8 22.4 23.6 22.4 25.0 26.9

ROAA 17.4 17.8 15.2 16.1 16.6 15.6 17.2 18.6

ROCE 25.9 26.6 22.2 24.7 26.1 25.3 27.3 30.3

ROIC 27.4 27.0 24.1 27.4 29.9 28.5 28.5 29.7

Net debt to equity n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.



Current ratio (x) 2.3 2.5 2.5 2.1 2.3 2.0 1.7 1.8

Net interest cover (x) n.a. 466.7 n.a. n.a. n.a. n.a. n.a. n.a.


Free cash flow yield 1.4 1.2 2.4 2.3 2.5 3.1 1.7 3.9

Company profile

Founded in 1981 and listed in 1999, Advantech is the largest industrial PC (IPC) maker worldwide

in terms of 2014 embedded board sales, followed by the company’s main competitors, Germany-

based Kontron and US-based Radiant Systems (acquired by system integrator NCR in 2011). The

company mainly provides embedded computing boards, chassis, industrial computers, applied

computers and design-in services. The businesses are categorised into 4 lines: embedded design-

in, industrial IoT, smart city solutions and global services.

34


Secure leadership in the IPC industry

Industrial IoT: the key growth theme

Being the world’s largest IPC company (in terms of 2015 revenue), Advantech is in a

strong position to benefit from the growing trend of industrial IoT. In fact, among the

company’s 4 major business segments – ie, Embedded Design-in, Industrial IoT, Smart

City Solutions and Global Services – we expect industrial IoT (30% of 2015 revenue) to

post stronger growth potential along with a higher gross margin (likely around 50%) than

the others.

Advantech: major business segments and related sub-divisions

Embedded Design-In Network & Communications

Bladed Computing & Systems

Network Appliances

Network Virtualization Platforms

Network & Embedded Switches

Broadcasting & Surveillance Platforms

Embedded Core Computing

Embedded Box Computer

Modular Computing Boards

Wireless IoT Modules

Display Systems & Gaming Solutions

Industrial Motherboard & DTOS

Embedded Peripherals

Industrial DMS

Applied Computing DMS

Embedded DMS

Network Appliance DMS

Component Purchasing Service

Industrial IoT Industrial Automation

Industrial I/O & Controllers

Industrial HMI

Automation Computing

IoT Devices & Solutions

WebAccess+ Solutions

iFactory (Industry 4.0) Solutions

Machine Automation Solutions

Power & Energy Solutions

Intelligent Systems

Industrial Computers

Industrial Servers & Storage

Intelligent Video Solutions

Intelligent IoT Modules

Transportation Solutions

iConnectivity

Industrial Communications

Wireless industrial Comm.

iNetworking (B+B SmartWorx)

Smart City Solutions Service Automation Platforms

Industrial Mobile Computing

iRetail Platforms

Medical Computing & Tablets

In-Vehicle Computing

Intelligent Service Solutions

Intelligent Hospital

Digital Logistics & Fleet Management

Intelligent Retail & Hospitality

Global Services

Source: Company

Advantech: revenue breakdown by segment Advantech: revenue breakdown by region

Source: Company, Daiwa forecasts Source: Company

Infrastructure related spending: a main driver in 2016E

Advantech’s Industrial IoT segment consists of 2 major businesses – intelligent systems

and IA. The company’s major applications currently include infrastructure, transportation,

IA and energy related areas.

Demand for intelligent systems for the infrastructure/transportation/energy segments was a

bright spot in 2015, and should remain strong in 2016, as these projects are mostly related

to government spending, which tend to increase during a downturn as an effort to boost an

economy, based on Advantech’s past experience.

49% 51% 52% 51%

32% 30% 31% 34%

8% 8% 6% 6%11% 12% 10% 9%

0%

20%

40%

60%

80%

100%

2014 2015 2016E 2017E

Embedded Design-in Industrial IoT Smart City Solution Global Service

31% 29% 29%

14% 15% 16%

29% 29% 31%

14% 14% 13%

7% 7% 6%5% 7% 6%

0%

20%

40%

60%

80%

100%

2013 2014 2015

North America Europe Greater China Asia/InterCon DMS-Direct Others

We expect Industrial IoT

to offer stronger sales

momentum and better

gross margin than other

businesses of

Advantech

Intelligent systems

should remain a brighter

spot in the industrial IoT

area; IA has been slow

but may recover in 2016

35


As for the IA business, however, the demand was lacklustre in 2015 due mainly to the

weakening of China’s economy. While macro uncertainties may remain a drag, we see

potentially positive catalysts in 2016, as demand for manufacturing facility upgrades (as

opposed to new additions) look poised to become a strong demand driver for the IA

business this year.

In terms of regions, Advantech expects China to remain its most important market for the

Industrial IoT segment, followed by North America and Europe.

Acquisition of B+B SmartWorx – positive synergies in the long run

A deal to enhance industrial IoT capability

In November 2015 Advantech announced the acquisition of a 100% stake in B+B

SmartWorx, a US-based unlisted company, for USD99.85m (~TWD3.3bn). B+B

SmartWorx specialises in industrial networks and provides intelligent M2M and IoT-

connectivity solutions for wireless and wired networks used in remote and demanding

environments. According to Advantech, the deal was settled in early 2016, so the revenue

from B+B SmartWorx was consolidated into Advantech from January 2016.

Likely benefits

We believe the potential benefits from this deal include:

For the next 6-12 months, while the M&A integration is under way, we expect the

potential benefits of this deal to be all about cross-selling. B+B Smartworx’s client base

is mainly located in North America (about 58% of revenue) and Europe (28%), which

should help to potentially enlarge Advantech’s client reach. Likewise, Advantech’s

strength in Asia, particularly in Greater China, will also help facilitate B+B Smartworx’s

client penetration.

For the longer term, we expect more substantial business synergies to emerge from

2017 onwards, as this deal will strengthen Advantech’s industrial IoT-related capabilities

and facilitate the company’s expansion in the industrial connectivity market. We look for

B+B Smartworx to contribute 4%/6% to Advantech’s revenue in 2016E and 2017E,

respectively, with earnings contributions of about 2%/4%.

Advantech: major M&A transactions in recent years

Time Acquirer Acquisition target Major business Deal value Post-Deal Holding Remark

May-07 Advantech Netstar Technologies Industrial communication OEM/ODM TWD 155m 62% Merged into Advantech in 2014

Mar-10 Advantech DLoG GmbH Vehicle-mounted computers EUR 12.85m 100% Co-branding "Advantech-DLoG"

May-10 Advantech Broadwin Automation and smart-grid software TWD 90m 70%

Nov-10 Advantech Innocore Gaming Gaming related industrial PC solutions GBP 334m 100% Co-branding "Advantech-Innocore"

Nov-10 Advantech ACA Digital Industrial portable products TWD 93m 100%

Jan-12 Advantech Advansus Corp Industrial PC TWD 306m 100% Advantech bought 50% stake of Advansus from Pegatron

Dec-12 Advantech BICOM Information Technology Digital signage TWD 60m 100%

Aug-13 Advantech AdvanPOS POS products TWD 319m 70% Maintaining "AdvanPOS" brand

Sep-13 Advantech LNC Machine control and robotics TWD 730m 100% Co-branding "Advantech-LNC"

Nov-13 Advantech GPEG Intelligent display GBP 585m 100% Co-branding "Advantech-GPEG"

Nov-15 Advantech B+B SmartWorx Industrial connectivity solutions USD 99.85m 100%


We expect B+B

SmartWorx to bring

positive synergies, but

may cause higher opex

in 1H16

36



Financial update

Revenue momentum looks sustainable

Following somewhat modest 6% YoY revenue growth for 2015, Advantech’s revenue

should increase by 20% for 2016E and 17% for 2017E, based on our forecasts. As

indicated earlier, we expect the growth to be mainly driven by the Industrial IoT segment,

along with an extra revenue contribution from the newly acquired B+B SmartWorx. We also

expect other segments, like Embedded Design-In, to post low double-digit revenue growth.

Likely short-term pressure on operating margins

We expect no major volatility in Advantech’s gross margin trend, which we forecast to

remain in the range of 40-41% for 2016-17. That said, we do have some concerns about

its opex. The company’s operating margin dipped in 3Q15 (to 14.0%, down from 16.3% in

2Q15) due to higher expenses for R&D and software platform related royalties. While it

soon recovered in 4Q15 (to 16.6%), we expect Advantech’s software related R&D

expenses to remain high in 2016E, and believe the consolidation of B+B SmartWorx could

lead to an increase in opex, including amortisation expenses from the acquisition premium.

As such, we forecast the company’s operating margins in 2016E to be in a range of 15.5%,

close to the mid-point of its past-3-year range of 14.0-16.8%. Nevertheless, we do expect

revenue growth from 2Q16 onwards to partially offset the pressure due to improving

operating leverage, with a likely further improvement in 2017E on potential synergies from

B+B SmartWorx.

Earnings revisions

We are raising our 2015-17 EPS forecasts by 2.6-6.1%, mainly to reflect: 1) the additional

revenue contribution from newly acquired B+B SmartWorx, which started from January

2016, and 2) likely lower operating margins (particularly in 1H16E) due to initially higher

opex from the B+B SmartWorx acquisition.

Advantech: revenue and earnings-forecast revisions and comparison vs. consensus

2015 2016E 2017E

(TWDm) Previous Actual Consensus Previous New Consensus Previous New Consensus

Revenue 37,982 38,001 38,322 43,697 45,439 42,776 50,089 53,245 48,159

Diff (%) 0.0% -0.8% 4.0% 6.2% 6.3% 10.6%

Gross Margin (%) 40.1% 40.4% 40.1% 40.2% 40.8% 40.6% 40.3% 41.1% 40.7%

Operating profit 5,795 5,929 5,894 6,968 7,029 6,711 8,080 8,683 7,674

Operating Margin (%) 15.3% 15.6% 15.4% 15.9% 15.5% 15.7% 16.1% 16.3% 15.9%

Net profit 4,973 5,104 5,123 6,004 6,173 5,837 7,017 7,443 6,710

EPS (TWD) 7.87 8.08 8.11 9.50 9.77 9.24 11.11 11.78 10.62

Diff (%) 2.6% -0.4% 2.8% 5.7% 6.1% 10.9%


Advantech should see

solid revenue growth

momentum, but may

face near-term operating

margin pressure due to

its acquisition

We revise up our

earnings forecasts to

factor in the potential

M&A impact

37


Advantech: quarterly and annual P&L statement

2015 2016E

(TWDm) 1Q 2Q 3Q 4Q 1QE 2QE 3QE 4QE

2014 2015 2016E

Net revenue 8,785 10,027 9,438 9,751 9,615 11,629 11,814 12,380

35,732 38,001 45,439

COGS (5,194) (6,046) (5,691) (5,724) (5,705) (6,893) (6,992) (7,309)

(21,339) (22,656) (26,899)

Gross profit 3,591 3,980 3,746 4,027 3,910 4,737 4,822 5,071

14,393 15,345 18,540

Operating costs (2,240) (2,348) (2,422) (2,406) (2,500) (3,000) (2,977) (3,033)

(8,884) (9,416) (11,511)

Operating profit 1,351 1,632 1,324 1,621 1,410 1,736 1,845 2,038

5,508 5,929 7,029

Non-operating profit 129 (8) 195 45 137 119 166 65

547 361 487

Pre-tax profit 1,480 1,625 1,519 1,666 1,547 1,855 2,011 2,103

6,055 6,290 7,517

Income taxes (274) (292) (283) (314) (271) (325) (352) (368)

(1,147) (1,185) (1,344)

Net profit 1,207 1,328 1,228 1,342 1,271 1,524 1,651 1,727

4,908 5,104 6,173

Net EPS (TWD) 1.91 2.10 1.94 2.12 2.01 2.41 2.61 2.73

7.78 8.08 9.77

Operating Ratios

Gross margin 40.9% 39.7% 39.7% 41.3% 40.7% 40.7% 40.8% 41.0%

40.3% 40.4% 40.8%


15.4% 15.6% 15.5%

Pre-tax margin 16.9% 16.2% 16.1% 17.1% 16.1% 16.0% 17.0% 17.0%

16.9% 16.6% 16.5%

Net margin 13.7% 13.2% 13.0% 13.8% 13.2% 13.1% 14.0% 13.9%

13.7% 13.4% 13.6%

YoY%

Net revenue 8% 8% 3% 6% 9% 16% 25% 27%

17% 6% 20%

Gross profit 9% 9% 3% 4% 10% 14% 23% 28%

14% 7% 21%

Operating profit 6% 7% 4% 9% 9% 19% 29% 26%

18% 8% 19%

Pre-tax profit 3% 9% -5% 9% 5% 14% 32% 26%

17% 4% 20%

Net profit 5% 10% -7% 9% 5% 15% 34% 29%

19% 4% 21%

QoQ%

Net revenue -4% 14% -6% 3% -1% 21% 2% 5%

Gross profit -2% 11% -6% 8% -3% 21% 2% 5%

Operating profit 4% 21% -19% 22% -13% 23% 6% 10%

Pre-tax profit -4% 10% -7% 10% -7% 20% 8% 5%

Net profit -2% 10% -8% 9% -5% 20% 8% 5%


Recommendation

Upgrade to Outperform

We upgrade our rating on Advantech to Outperform (2) from Hold (3), and bump up our 12-

month target price to TWD254 (from TWD212), based on a higher target PER of 26x (ie,

the mean of the stock’s past-3-year PER range of 16-32x; vs. the previous target PER of

22x) applied to our 2016E EPS. We are raising our target PER, as we expect Advantech to

resume strong earnings growth from 2016E onwards, following the relatively muted 2015

(with net profit up just 4% YoY). In fact, our new target price suggests a 2017E PER of 22x,

which does not look demanding to us, if the potential synergies from the acquisition of B+B

SmartWorx emerge in 2017E as we expect.

Advantech: 1-year-forward PER bands Advantech: 1-year-forward PBR bands


0

50

100

150

200

250

300



(TWD)

0

50

100

150

200

250

300


Share price 1.5x 3x 5x 7x

(TWD)

38


Catalysts and risks

The potential catalysts we see for Advantech’s share price include:

Sustained revenue strength from both organic growth and the contribution from the M&A

deal.

An operating margin recovery after mid-2016E.

The downside risks to our positive view:

A worse-than-expected global economy and currency volatility, which could put pressure

on both revenue and earnings.

Slower-than-expected M&A integration, which would suggest worse-than-expected

operating margins.



Investment case: We initiate coverage of Adlink Technology (Adlink) with an Underperform (4) rating, driven by our concerns over lacklustre industrial automation (IA)-related demand globally and a likely spike in the company’s operating expenses for 2016.

Expecting short-term pain from M&A activity. Adlink’s latest acquisition,

UK-based software firm Prism Tech (PT) in 2015, should support its IoT-

related business ambitions in the long run. However, the deal is likely to

push up Adlink’s operating expenses in 1H16, due to M&A integration costs

and the related amortisation. We believe this will lead to a negative surprise

in the 1H16 earnings, as the market still expects Adlink to see generally

stable operating-margin trends (on the Bloomberg consensus estimates).

Sluggish IA demand still a concern. The slowdown in demand for IA-

related products, accounting for 35-40% of Adlink’s 2015 revenue (under its

MAPS and MCPS businesses), could be a drag on the company’s revenue

growth for 2016. We do see some company-specific growth drivers (eg, its

business with Agilent), but these are unlikely to offer much instant support.

Slowing MAPS business could weigh on its gross margin. We expect

Adlink’s high-margin MAPS business to see slower YoY revenue growth for

2016E, weighing on its gross margin (40.7% for 2016E, vs. 41.3% for

2015). While the PT business has a high gross margin, its limited revenue

contribution initially means the potential benefits could be marginal in 2016.

Financial outlook. We expect Adlink to post stable revenue growth (10%

YoY for 2016E, 14% YoY for 2017E), but are cautious on its operating

margin. Aside from the negative impact of the PT deal, we expect extra

expenses from Adlink’s restricted employee stock plan (effective from

September 2015) to push down the bottom line. We forecast the operating

margin to drop to 7.5% for 2016E (vs. 8.7% for 2015 and 8.6% for 2014).

Catalysts: Adlink’s likely disappointing operating margin in the coming quarters would be the main negative share-price catalyst.

Valuation: We initiate with an Underperform (4) rating and 12-month TP of

TWD68, based on a 2016E PER of 22x (ie, the mean of its past-3-year

trading range of 12-40x). While we expect synergies from Adlink’s PT deal

and a recovery in IA-related demand going forward, we believe a weaker-

than-expected operating margin in 1H16 could disappoint investors. Hence,

our 2016-17E EPS are 14-23% below the Bloomberg consensus.

Risks: The key upside risks to our view: 1) faster-than-expected recovery in the global capex trend, and 2) if the integration of PT goes more smoothly than we assume.

23 March 2016

Adli nk Technolog y

Initiation: under transition

Lacklustre demand for industrial automation is a lingering concern

Likely disappointing operating margins also a negative catalyst

vertical markets should help it benefit from the IA/IoT trend Initiating with an Underperform (4) rating and target price of TWD68


Adlink Technology (6166 TT)

Target price: TWD68.00

Share price (21 Mar): TWD76.00 | Up/downside: -10.5%

Steven Tseng(886) 2 8758 6252

[email protected]

Jack Lin(886) 2 8758 6253

[email protected]

90

108

125

143

160

60

71

83

94

105



Adlink Tec (LHS)Relative to TWSE Index (RHS)

(TWD) (%)

12-month range 64.75-100.84




Major shareholder Chroma Ate Inc (11.3%)



Revenue (m) 9,068 10,002 11,437

Operating profit (m) 785 747 1,064

Net profit (m) 608 619 851


EPS change (%) (5.5) 1.9 37.4

Daiwa vs Cons. EPS (%) (7.8) (23.4) (13.6)

PER (x) 25.1 24.6 17.9


DPS 1.9 1.8 1.9

PBR (x) 3.9 3.0 2.7

EV/EBITDA (x) 14.6 12.9 9.1

ROE (%) 16.2 13.7 15.9

40

Adlink Technology (6166 TT): 23 March 2016



Growth outlook Adlink: net profit and ROE for 2013-17E

We forecast Adlink’s revenue to grow by 10% YoY for 2016

and 14% for 2017, respectively, which are generally in line

with management’s growth targets of 15-20% YoY. Despite

the sustained revenue growth momentum, we actually

expect slower net profit growth for 2016E (+2% YoY, vs.

+3% YoY for 2015), due to the likely higher opex for R&D,

its employee stock plan, and the PT acquisition.


Valuation Adlink: 1-year forward PER bands

We set our 12-month target price for Adlink at TWD68,

based on a target PER of 22x (ie, the mean of the stock’s

past-3-year trading range of 12x-40x) on our 2016 EPS

forecast. While we do expect synergies from Adlink’s M&A

move (PT deal) and a recovery in industrial-automation

demand globally going forward, the likely disappointing

operating margins from 4Q15 would be a major negative

share-price catalyst.


Earnings revisions Adlink: Bloomberg 2015-16E EPS forecast revisions

The Bloomberg consensus forecasts for Adlink have been

generally stable since February 2014, but we have seen

some downward revisions since mid-2015. Our 2016-17E

EPS are 14-23% below the Bloomberg consensus

estimates, as we expect the company’s operating

expenses in the coming quarters to be much higher than

the market expects. We therefore expect the consensus to

cut forecasts for 2016-17E down the road.

Source: Bloomberg :

0%

20%

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60%

80%

100%

120%

140%

0

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4

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8

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12

14

2013 2014 2015 2016E 2017E



(TWDbn)

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(TWD)

41


Financial summary

Key assumptions


Cash flow (TWDm)


Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

MAPS revenue YoY % n.a. n.a. n.a. 8.1 60.9 (5.9) 3.8 20.1

MCPS revenue YoY % n.a. n.a. n.a. 7.5 27.9 43.6 10.5 17.9

ECPS revenue YoY % n.a. n.a. n.a. 10.4 (19.1) (16.7) 12.2 5.4

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

MAPS 1,800 1,636 1,543 1,668 2,683 2,525 2,621 3,146

MCPS 0 0 1,444 1,553 1,987 2,854 3,154 3,718

Other Revenue 2,783 3,370 2,608 3,259 3,377 3,688 4,227 4,572

Total Revenue 4,583 5,006 5,595 6,480 8,047 9,068 10,002 11,437

Other income 0 0 0 0 0 0 0 0

COGS (2,518) (2,849) (3,305) (3,849) (4,701) (5,321) (5,935) (6,739)

SG&A (936) (1,098) (1,228) (1,298) (1,580) (1,710) (2,012) (2,236)

Other op.expenses (403) (525) (748) (818) (1,075) (1,252) (1,307) (1,398)

Operating profit 726 534 315 515 691 785 747 1,064

Net-interest inc./(exp.) (22) (48) (42) (12) (9) (9) (9) (9)

Assoc/forex/extraord./others (12) 53 (33) 31 73 (7) 39 15

Pre-tax profit 692 539 240 570 755 769 778 1,070

Tax (90) (124) (46) (114) (165) (159) (156) (217)

Min. int./pref. div./others (2) 1 0 (1) (2) (2) (2) (2)

Net profit (reported) 600 416 194 455 588 608 619 851

Net profit (adjusted) 600 416 194 455 588 608 619 851

EPS (reported)(TWD) 4.990 3.026 1.225 2.662 3.208 3.031 3.088 4.244

EPS (adjusted)(TWD) 4.990 3.026 1.225 2.662 3.208 3.031 3.088 4.244


DPS (TWD) 1.188 2.482 1.000 1.082 1.503 1.909 1.818 1.853

EBIT 726 534 315 515 691 785 747 1,064

EBITDA 822 686 524 710 925 1,036 1,114 1,531

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Profit before tax 692 539 240 570 755 769 778 1,070


Tax paid (90) (124) (46) (114) (165) (159) (156) (217)

Change in working capital (567) (283) 93 24 (571) (82) (155) (212)

Other operational CF items 198 36 234 99 244 130 0 0

Cash flow from operations 328 320 730 774 498 908 832 1,108

Capex (456) (182) (97) (61) (172) (821) (720) (343)

Net (acquisitions)/disposals (28) (8) (261) 0 (15) 0 0 0

Other investing CF items 11 5 (129) 60 (41) (186) 0 0

Cash flow from investing (473) (184) (487) (1) (229) (1,007) (720) (343)

Change in debt 277 335 (142) (592) 185 784 0 0


Dividends paid (143) (298) (137) (171) (257) (350) (365) (371)

Other financing CF items 17 9 0 21 6 34 7 9

Cash flow from financing 151 46 (280) (306) (66) 468 603 (362)

Forex effect/others (12) 11 (20) 8 27 0 0 0

Change in cash (6) 193 (57) 474 230 369 715 403

Free cash flow (128) 139 633 712 325 87 112 765

42




Key ratios (%)


As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Cash & short-term investment 607 800 830 1,178 1,184 1,656 2,371 2,774

Inventory 984 1,155 1,134 1,148 1,573 1,741 1,845 2,036

Accounts receivable 972 967 1,116 1,308 1,664 1,527 1,835 2,090


Total current assets 2,701 3,060 3,252 3,720 4,539 5,110 6,238 7,086

Fixed assets 1,005 1,148 1,071 1,044 1,107 1,676 2,030 1,906


Other non-current assets 564 491 576 580 763 814 814 814

Total assets 4,271 4,699 4,900 5,344 6,409 7,601 9,082 9,806

Short-term debt 578 756 713 357 750 1,534 1,534 1,534

Accounts payable 887 823 1,156 1,201 1,554 1,503 1,760 1,993

Other current liabilities 211 160 245 493 390 376 376 376

Total current liabilities 1,676 1,739 2,114 2,051 2,694 3,413 3,669 3,903

Long-term debt 305 460 283 0 0 0 0 0

Other non-current liabilities 8 12 13 91 97 281 281 281

Total liabilities 1,988 2,211 2,410 2,142 2,791 3,694 3,950 4,184

Share capital 1,202 1,375 1,581 1,709 1,834 2,005 2,005 2,005

Reserves/R.E./others 1,075 1,106 904 1,487 1,777 1,893 3,118 3,609

Shareholders' equity 2,277 2,481 2,485 3,196 3,611 3,898 5,123 5,614

Minority interests 5 6 6 6 7 9 9 9

Total equity & liabilities 4,271 4,699 4,900 5,344 6,409 7,601 9,082 9,806

EV 15,518 15,660 15,408 14,422 14,810 15,123 14,408 14,005

Net debt/(cash) 276 417 165 (820) (434) (122) (837) (1,240)

BVPS (TWD) 18.949 18.047 15.716 18.699 19.687 19.444 25.552 28.000

Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E

Sales (YoY) 71.5 9.2 11.8 15.8 24.2 12.7 10.3 14.3

EBITDA (YoY) 200.0 (16.5) (23.5) 35.3 30.4 12.0 7.5 37.5

Operating profit (YoY) 290.4 (26.6) (41.0) 63.6 34.2 13.6 (4.8) 42.4

Net profit (YoY) 263.6 (30.6) (53.4) 134.9 29.4 3.3 1.9 37.4

Core EPS (fully-diluted) (YoY) 263.0 (39.4) (59.5) 117.3 20.5 (5.5) 1.9 37.4


EBITDA margin 17.9 13.7 9.4 11.0 11.5 11.4 11.1 13.4



ROAE 29.1 17.5 7.8 16.0 17.3 16.2 13.7 15.9

ROAA 16.2 9.3 4.0 8.9 10.0 8.7 7.4 9.0

ROCE 25.8 15.5 8.8 14.6 17.4 16.0 12.3 15.4

ROIC 28.6 15.1 9.1 16.3 19.4 17.9 14.8 19.6

Net debt to equity 12.1 16.8 6.7 n.a. n.a. n.a. n.a. n.a.



Current ratio (x) 1.6 1.8 1.5 1.8 1.7 1.5 1.7 1.8

Net interest cover (x) 32.6 11.2 7.5 42.2 80.1 91.6 87.2 123.6


Free cash flow yield n.a. 0.9 4.2 4.7 2.1 0.6 0.7 5.0

Company profile

Founded in 1995 and listed in 2004, Adlink Technology (Adlink) is the third largest industrial PC (IPC) company in Taiwan in terms of 2015 revenue. It provides industrial embedded computers as well as smart displays & mobile computing platforms for 5 major vertical markets: machine automation & test measurement, telecommunications & networking, defence & transportation, infotainment, and medial & healthcare. The company has a global presence and ships products to more than 40 countries.

43


Company background

Adlink: third-largest IPC player in Taiwan

Founded in 1995, Adlink Technology was Taiwan’s third-largest industrial PC company in

terms of revenue for 2015, according to the company, after Advantech and Ennoconn. The

company first cut its teeth on embedded computing systems and moved into other

industrial PC businesses, including measurement/automation, telecoms/networking,

military/defence, infotainment/gaming, and medical.

In recent years, Adlink made a series of acquisitions to beef up its capabilities, including

Ampro in 2008 (for rugged computing products), Lippert in 2012 (modular embedded

computing solutions for the transportation and healthcare sectors), Penta in 2014 (panel

PCs for the medical/retail sectors), and Prism Tech in 2015 (IoT-related software).

Adlink: revenue breakdown by segment Adlink: vertical market focus by product segment

Vertical Markets MAPS ECPS MCPS DCPS

Measurement

Telecom/Networking

Military/Transportation

Infotainment

Medical

IoT

Source: Company


Adlink: revenue breakdown by region (as of 2015) Adlink: shareholding structure (as of February 2016)

Source: Company

Source: Company, TEJ Note: *Excluding management team and Chroma (supervisor)

33% 28% 26% 28%

22%17% 17% 15%

25%31% 32% 33%

14% 16% 16% 15%

4% 5% 6% 7%2% 3% 3% 3%

0%

20%

40%

60%

80%

100%

2014 2015 2016E 2017E

MAPS ECPS MCPS DMS DCPS Others

North America, 28%

EMEA, 17%Asia Pacific, 31%

China, 16%

Others, 5%

Management Team, 5% Board

Members*, 5%

Chroma, 11%

Agilent, 7%

Free Flow, 71%

For 2015, Adlink was the

third-largest IPC player

in Taiwan, in terms of

revenue

44


Major business lines

Adlink has the following 5 major business lines (please refer to the revenue breakdown

charts on the previous page):

Measurement and automation product segment (MAPS): This is one of Adlink’s most

important businesses, accounting for 28% of 2015 revenue. The company’s

measurement products include data acquisition (DAQ) cards, PCI extensions for

instrumentation (PXI), which are widely used in test/measurement equipment in the

semiconductor, LCD, and LED industries. Its automation products include motion control

cards, machine vision and programmable automation controllers (PAC). Agilent is a key

client here, and its relationship with Adlink is closer since Agilent made a direct

investment (6.8% stake currently) in Adlink in 2013. Adlink’s MAPS business enjoys the

highest gross margin among all of the company’s major product segments.

Module computing product segment (MCPS): This is another major business for

Adlink, accounting for 31% of its 2015 revenue. Products include motherboards and

modules that are applied to POS, infotainment, military, medical, and factory

automation-related products. The company’s MCPS revenue growth was strong in 2015

(over 40% YoY, due mainly to growing orders from gaming-related clients), but is likely

to slow in 2016E due to a higher base of comparison in 2015.

Embedded computing product segment (ECPS): Adlink mostly supplies Compact

PCI cards, ATCA boards and embedded systems for end applications such as

transportation, network appliance and base station servers for the telecoms segment.

This business was weak in 2015 (revenue fell 17% YoY), due to the much weaker-than-

expected operating performance of Adlink’s major telecoms client.

Design manufacture service centre (DMSC): DMSC is basically an ODM/EMS

business. Most of Adlink’s new clients or new products tend to be categorised under this

business line initially, and then shift into other business areas in due course. We believe

this business has the lowest gross margin among all of Adlink’s major product lines.

Display computing product segment (DCPS): This is a new segment since 2015,

following the acquisition of Penta in early 2014. The company’s major products under

this business are panel PCs, mostly for medical and retail sectors.

Of all of Adlink’s

business lines, its MAPS

and MCPS businesses

are the main revenue

contributors

45


Transition time

Industrial-automation demand still a concern

Cloudy macro outlook could weigh on MAPS business

Compared to other the IPC companies in Taiwan, Adlink’s strength is in its measurement

and automation-related products (ie, under its MAPS business), which are highly

correlated to industrial automation (IA) demand globally. Adlink’s IA-related business

accounted for 35-40% of the company’s 2015 revenue, and includes its MAPS business

and part of its MCPS business (industrial robot controllers). Also, as the MAPS business

enjoys the highest gross margin (likely at around 45%) among all of Adlink’s major

business lines, we believe the revenue growth momentum in this area will have a more

visible impact on Adlink’s profitability for 2016.

Along with the weaker year-on-year automation-related capex worldwide, Adlink’s MAPS

revenue was down 6% YoY for 2015, much weaker than the 61% YoY growth for 2014. The

following chart shows that the YoY growth of Adlink’s MAPS revenue does appear to be

largely in line with trends in US PMI and China PMI for the past few years. But the ongoing

macro uncertainties globally, could suggest lingering global capex weakness, and thus we

remain cautious on the growth outlook for the company’s MAPS business in 2016.

Adlink: comparison of YoY growth of MAPS revenue, US PMI, and China PMI

Source: Company, ISM, CASIN

That said, we see some silver linings

Despite our caution, it’s worth noting that, as shown in the chart, the YoY growth of MAPS

revenue seemed to have bottomed in 1H15, although the recovery has been modest thus

far. We currently expect MAPS revenue to post single-digit YoY growth in 2016, as Adlink

does have a few company-specific drivers, which may partially offset the macro weakness:

Increasing automation demands in Apple supply chain – our market survey

suggests that Adlink has been involved in the automation endeavours in Apple supply

chain for both smartphone and wearables, with major clients including Hon Hai, Largan,

TSMC, etc. In fact, Adlink indicated recently that the automation related component

demands in China have been improving since early 2016, which could be a positive sign

for potential recovery during the year.

Sustained demand from Agilent – Agilent has been a key client in MAPS business,

with its revenue contribution growing by 8% YoY in 2015. We expect the momentum to

remain generally sustainable in 2016.

46

48

50

52

54

56

58

60

-20%

0%

20%

40%

60%

80%

100%

Jan-

13

Mar

-13

May

-13

Jul-1

3

Sep

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Nov

-13

Jan-

14

Mar

-14

May

-14

Jul-1

4

Sep

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Nov

-14

Jan-

15

Mar

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May

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Jul-1

5

Sep

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Nov

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Jan-

16

MAPS Revenue (YoY) US PMI (RHS) China PMI (RHS)

Lacklustre IA-related

demand globally could

weigh on Adlink’s MAPS

and MCPS businesses

for 2016

That said, we do see a

few company-specific

drivers in IA-related

areas

46


Prism deal: short-term pain before long-term gain

M&A activities to bode well for long-term outlook

Like its IPC peers in Taiwan, Adlink has been proactively engaged in M&A activity over the

past 4 years to expand its exposure to its targeted vertical applications.

Adlink: Major M&A and investment activities in recent years

Time Acquirer Acquisition target Major business Deal

value

Post-Deal

Holding Remark

Dec-08 Adlink Ampro Computers Rugged computing products, modular embedded computing solutions USD20m 100% Maintaining "Ampro" brand

Jan-12 Adlink Lippert Embedded Computers GmbH

Transportation & healthcare (brand modularised PC supplier) EUR7m 100% Maintaining "Lipper" brand

Dec-12 Agilent Adlink Agilent invested in Adlink via a private placement as part of their strategic partnership; Agilent has been a client of Adlink since 2004

n.a. 7.39% Closer partnership in measurement products

Mar-14 Adlink PENTA GmbH Healthcare & industrial automation (medical embedded PC and HMI) mainly in Germany

USD7.4m 100% Maintaining "PENTA" brand

Dec-15 Adlink PrismTech Software platforms/tools for IoT, mainly for data distribution service (DDS) USD16.6m 100% Using PrismTech's "Vortex" (an intelligent data-connectivity platform)


The latest M&A deal: Prism Tech

PT is Adlink’s most recent acquisition, and the deal was finalised in December 2015 at a

cost of USD16.6m (~TWD550m). PT is a UK-based software firm that has solid

experiences in the development and implementation of Data Distribution Services (DDS)

standards for IoT applications. Adlink expects to combine PT’s software capability and

Adlink’s hardware strength to create integrated platforms and solutions to accelerate the

implementation of IIoT (Industrial IoT) for its clients. To finance this deal, Adlink undertook

a public offering of 15m new shares (nearly 7.5% of the original outstanding) and raised

TWD960m in Jan 2016.

According to Adlink, PT made a net loss in 2015, but should break even for 2016E, on the

back of tighter cost controls and once it is fully integrated with Adlink. In fact, in Adlink’s

forecasts (see the following table), it expects PT to register strong revenue and earnings

growth from 2017E, driven by the high gross margin of PT’s software business and the

potentially strong synergies from the acquisition. We currently expect PT to contribute

about 3% and 5% of Adlink’s revenue for 2016E and 2017E, respectively.

Adlink: company forecasts for Prism Tech

(TWDm) 2016E 2017E 2018E 2019E 2020E

Net revenue 425.6 617.1 894.8 1297.5 1881.3

Gross profit 323.4 469.0 680.0 986.1 1429.8

Operating profit 4.3 60.4 169.3 347.7 682.9

Net profit 2.8 39.3 110.1 226.0 443.9

Operating ratios

Gross margin 76.0% 76.0% 76.0% 76.0% 76.0%

Operating margin 1.0% 9.8% 18.9% 26.8% 36.3%

Net margin 0.6% 6.4% 12.3% 17.4% 23.6%

YoY (%)

Net revenue n.a. 45% 45% 45% 45%

Gross profit n.a. 45% 45% 45% 45%

Operating income n.a. 1320% 180% 105% 96%

Net income n.a. 1320% 180% 105% 96%

Source: Company

Rosy long-term results from PT deal, but short-term challenges

While the long-term potential upside from this M&A looks rosy to us, we are cautious about

the initial earnings impact of the acquisition, as PT has much higher operating expenses,

which will be equivalent to about 75% and 66% of its 2016 and 2017 revenue, respectively,

according to Adlink’s forecasts. Also, the additional amortisation expenses due to the

acquisition premium will add to Adlink’s expense burden. We expect all these factors to

result in operating margin downside, particularly for 1H16 (our margin assumptions are

covered in the financial update section of this report).

PT deal should bring

favourable synergies in

the long run, but we are

cautious on the opex

impact for 2016E

47


Shifting revenue mix could weigh on the gross margin

Diverse exposure to support revenue growth

Adlink’s diverse exposure to multiple segments has helped to support its sustained

revenue growth in the past, and we expect this to continue despite the macro uncertainties

globally. For 2016E, apart from the PT deal, we expect Adlink’s organic growth drivers to

come from:

DCPS: revenue for this business grew by 54% YoY for 2015, on a low comparison base,

and we expect it to remain strong for 2016E. This is mainly due to its panel PC business

from Penta, a German company that Adlink acquired (100%) in March 2014, as it

continues to penetrate a wider client base, particularly in the medical segment.

MCPS: this business saw revenue growth of over 40% YoY for 2015 revenue, and we

expect this segment to continue to post double-digit percentage revenue growth in

2016E, driven mainly by gaming/infotainment (thanks to its gaming clients from the US

and Australia), which should help to offset the uncertainty in Adlink’s factory-automation-

related products (eg, industrial robot controllers).

ECPS: revenue for this business fell by 17% YoY for 2015, due largely to weaker

demand from its key telecoms client, Nokia, which has been hurt by forex volatility and

prolonged inventory adjustments. Looking into 2016E, Adlink feels positive on the

revenue growth potential of its new products for the telecoms/networking sectors, which

target media-cloud and data-cloud-related applications.

Slowing MAPS business could imply lingering margin pressure

While we expect the company’s DCPS/MCPS/ECPS businesses to support Adlink’s

revenue growth for 2016E, it’s worth noting that the MAPS business, which we believe

offers a higher (vs. other business lines) gross margin of at least 45%, should see a lower

revenue contribution for 2016E, at 26%, vs. 28% for 2015, on back of more modest

revenue growth momentum, due to the slowdown in IA-related demand. We hence expect

some pressure on Adlink’s gross margin for 2016.

Adlink’s sales mix

change likely to put

pressure on the

gross margin

48



Financial update

Operating margin will be the key indicator to watch

We forecast revenue growth of 10% YoY for 2016E and 14% for 2017E. These numbers

are generally in line with Adlink management’s annual growth target of 15-20% YoY. A

potential wildcard to our 2Q16 revenue forecast would be if the integration/consolidation of

the PT deal is delayed. We currently expect this to happen in 2Q16.

Compared to our relatively stable revenue growth forecasts, however, we are more

cautious on Adlink’s operating margin for 1H16. Aside from the impact of the PT deal, we

also expect the company’s expenses to rise due to Adlink’s restricted employee stock plan

(total 1.5m shares, effective from September 2015). As such, we expect Adlink’s operating

margin to drop to 7.5% for 2016E, from 8.7% for 2015E and 8.6% in 2014, with particular

downward pressure in 1H16.

Adlink: quarterly and annual P&L statement

2015 2016E

(TWDm) 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 2014 2015 2016E

Net revenue 2,184 2,394 2,333 2,157 2,024 2,696 2,615 2,667

8,047 9,068 10,002

COGS (1,208) (1,438) (1,418) (1,257) (1,137) (1,614) (1,587) (1,597)

(4,701) (5,321) (5,935)

Gross profit 976 955 915 900 887 1,082 1,028 1,071 3,346 3,747 4,066

Operating expenses (707) (734) (763) (757) (776) (899) (821) (823) (2,655) (2,962) (3,319)

Operating profit 269 221 153 142 110 183 207 248

691 785 747

Non-operating profit (22) (5) 36 (25) 11 5 10 5

64 (16) 30

Pre-tax profit 247 216 189 117 122 187 216 253 755 769 778

Income taxes (57) (51) (32) (20) (24) (43) (43) (45) (167) (161) (159)

Net profit 189 164 157 97 97 143 173 207

588 608 619

Net EPS (TWD) 1.03 0.89 0.78 0.49 0.45 0.67 0.80 0.96

3.21 3.03 3.09

Operating Ratios

Gross margin 44.7% 39.9% 39.2% 41.7% 43.8% 40.1% 39.3% 40.1%

41.6% 41.3% 40.7%


8.6% 8.7% 7.5%

Pre-tax margin 11.3% 9.0% 8.1% 5.4% 6.0% 6.9% 8.3% 9.5%

9.4% 8.5% 7.8%

Net margin 8.7% 6.9% 6.7% 4.5% 4.8% 5.3% 6.6% 7.7%

7.3% 6.7% 6.2%

YoY%

Net revenue 31% 6% 14% 3% -7% 13% 12% 24%

24% 13% 10%

Gross profit 29% 9% 19% 1% -6% 12% 12% 27%

27% 12% 9%

Operating profit 34% 2% 9% 8% -9% 13% 12% 19%

34% 14% -5%

Pre-tax profit 79% -19% -7% -21% -51% -13% 14% 116%

42% 2% 1%

Net profit 76% -18% 3% -24% -49% -13% 10% 112%

41% 3% 2%

QoQ%

Net revenue 5% 10% -3% -8% -6% 33% -3% 2%

Gross profit 17% -2% -4% -2% -1% 22% -5% 4%

Operating profit 159% -18% -31% -7% -22% 65% 13% 20%

Pre-tax profit 68% -13% -12% -38% 4% 54% 16% 17%

Net profit 47% -13% -5% -38% -1% 49% 20% 20%


Adlink: revenue and earnings forecasts and comparison vs. consensus

2015 2016E 2017E

(TWDm) Actual Consensus Daiwa Consensus Daiwa Consensus

Revenue 9,068 9,132 10,002 10,106 11,437 11,762

Diff (%) -0.7% -1.0% -2.8%

Gross margin (%) 41.3% 41.3% 40.7% 41.7% 41.1% 41.4%

Operating profit 785 833 747 985 1,064 1,230

Operating margin (%) 8.7% 9.1% 7.5% 9.7% 9.3% 10.5%

Net profit 608 659 619 808 851 985

EPS (TWD) 3.03 3.29 3.09 4.03 4.24 4.91

Diff (%) -7.8% -23.4% -13.6%


We expect Adlink’s

opex to spike due to the

employee stock plan

and PT acquisition

impact

49



Initiating coverage with an Underperform (4) rating

We initiate coverage on Adlink with an Underperform (4) rating. We set our 12-month target

price at TWD68, based on a target PER of 22x (ie, the mean of the stock’s past-3-year

trading range of 12x-40x) applied to our 2016E EPS. While we do see potential synergies

from the integration with PT and likely recovery in IA-related demand going forward, the

company’s likely rising opex pressure from 4Q15 could present a key downside share-price

risk, particularly when the street still seems to expect generally stable operating margins

for the next few quarters, as evidenced by the current Bloomberg consensus estimates.

We expect the potential margin disappointment for the next 2 quarters, and hence likely

lower-than-expected operating margin for 2016E, to be the main negative share price

catalyst.

Adlink: 1-year-forward PER bands Adlink: 1-year-forward PBR bands


Catalysts and risks

In our view, the main negative share-price catalyst would be:

The likelihood of a worse-than-expected operating margin in 1H16, as we expect

Adlink’s opex to be much higher due to its employee stock plan, as well as the negative

impact of the PT acquisition.

Ongoing weakness in IA demand, as IA-related business is a major revenue contributor

(35-40% of sales) and provides better profitability, so its on-going weakness could spell

likely downside risk to our earnings forecasts.

The key upside risks to our Underperform (4) view on the stock would be:

If the integration with PT is smoother than we expect and results in a faster recovery in

Adlink’s operating margin and, thus, better earnings growth for 2016E.

A secondary upside risk would be the faster-than-expected recovery in the company’s

IA-related segments, which could lead to upside to the company’s revenue growth.

0

20

40

60

80

100

120

140



(TWD)

0

20

40

60

80

100

120

140


Share price 1x 2x 3.5x 5.5x

(TWD)

We are cautious on

Adlink, due to likely

weaker IA-related

demand and a potential

opex hike in 2016E

50


Daiwa’s Asia Pacific Research Directory

HONG KONG

Takashi FUJIKURA (852) 2848 4051 [email protected]

Regional Research Head

Kosuke MIZUNO (852) 2848 4949 / (852) 2773 8273

[email protected]

Regional Research Co-head

John HETHERINGTON (852) 2773 8787 [email protected]

Regional Deputy Head of Asia Pacific Research

Rohan DALZIELL (852) 2848 4938 [email protected]

Regional Head of Product Management

Kevin LAI (852) 2848 4926 [email protected]

Chief Economist for Asia ex-Japan; Macro Economics (Regional)

Junjie TANG (852) 2773 8736 [email protected]

Macro Economics (China)

Jonas KAN (852) 2848 4439 [email protected]

Head of Hong Kong and China Property

Cynthia CHAN (852) 2773 8243 [email protected]

Property (China)

Leon QI (852) 2532 4381 [email protected]

Banking (Hong Kong/China); Broker (China); Insurance (China)

Anson CHAN (852) 2532 4350 [email protected]

Consumer (Hong Kong/China)

Jamie SOO (852) 2773 8529 [email protected]

Gaming and Leisure (Hong Kong/China)

Dennis IP (852) 2848 4068 [email protected]

Power; Utilities; Renewables and Environment (Hong Kong/China)

John CHOI (852) 2773 8730 [email protected]

Head of Hong Kong and China Internet; Regional Head of Small/Mid Cap

Kelvin LAU (852) 2848 4467 [email protected]

Head of Automobiles; Transportation and Industrial (Hong Kong/China)

Brian LAM (852) 2532 4341 [email protected]

Transportation – Railway; Construction and Engineering (China)

Jibo MA (852) 2848 4489 [email protected]

Head of Custom Products Group

Thomas HO (852) 2773 8716 [email protected]

Custom Products Group

PHILIPPINES

Bianca SOLEMA (63) 2 737 3023 [email protected]

Utilities and Energy

SOUTH KOREA

Sung Yop CHUNG (82) 2 787 9157 [email protected]

Pan-Asia Co-head/Regional Head of Automobiles and Components; Automobiles; Shipbuilding; Steel

Mike OH (82) 2 787 9179 [email protected]

Banking; Capital Goods (Construction and Machinery)

Iris PARK (82) 2 787 9165 [email protected]

Consumer/Retail

SK KIM (82) 2 787 9173 [email protected]

IT/Electronics – Semiconductor/Display and Tech Hardware

Thomas Y KWON (82) 2 787 9181 [email protected]

Pan-Asia Head of Internet & Telecommunications; Software – Internet/On-line Game

Kevin JIN (82) 2 787 9168 [email protected]

Small/Mid Cap

TAIWAN

Rick HSU (886) 2 8758 6261 [email protected]

Head of Regional Technology; Head of Taiwan Research; Semiconductor/IC Design (Regional)

Christie CHIEN (886) 2 8758 6257 [email protected]

Banking; Insurance (Taiwan); Macro Economics (Regional)

Steven TSENG (886) 2 8758 6252 [email protected]

IT/Technology Hardware (PC Hardware)

Christine WANG (886) 2 8758 6249 [email protected]

IT/Technology Hardware (Automation); Pharmaceuticals and Healthcare; Consumer

Kylie HUANG (886) 2 8758 6248 [email protected]

IT/Technology Hardware (Handsets and Components)

Helen CHIEN (886) 2 8758 6254 [email protected]

Small/Mid Cap

INDIA

Punit SRIVASTAVA (91) 22 6622 1013 [email protected]

Head of India Research; Strategy; Banking/Finance

Saurabh MEHTA (91) 22 6622 1009 [email protected]

Capital Goods; Utilities

SINGAPORE

Ramakrishna MARUVADA (65) 6499 6543 [email protected]

Head of Singapore Research; Telecommunications (China/ASEAN/India)

Royston TAN (65) 6321 3086 [email protected]

Oil and Gas; Capital Goods

David LUM (65) 6329 2102 [email protected]

Banking; Property and REITs

Shane GOH (65) 64996546 [email protected]

Small/Mid Cap (Singapore)

Jame OSMAN (65) 6321 3092 [email protected]

Telecommunications (ASEAN/India); Pharmaceuticals and Healthcare; Consumer (Singapore)

51


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52


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53


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The following explains the rating system in the report as compared to relevant local indices, unless otherwise stated, based on the beliefs of the author of the report.

"1": the security could outperform the local index by more than 15% over the next 12 months. "2": the security is expected to outperform the local index by 5-15% over the next 12 months. "3": the security is expected to perform within 5% of the local index (better or worse) over the next 12 months. "4": the security is expected to underperform the local index by 5-15% over the next 12 months. "5": the security could underperform the local index by more than 15% over the next 12 months. Disclosure of investment ratings

Rating Percentage of total

Buy* 63.9%

Hold** 21.3%

Sell*** 14.8%

Source: Daiwa

Notes: data is for single-branded Daiwa research in Asia (ex Japan) and correct as of 31 December 2015. * comprised of Daiwa’s Buy and Outperform ratings. ** comprised of Daiwa’s Hold ratings. *** comprised of Daiwa’s Underperform and Sell ratings. Additional information may be available upon request.

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