More takeovers in store for tech sector

THE wave of takeover activity in the tech sector looks set to grow stronger in the coming months, as several stocks in the industry remain undervalued.

Some of these firms include United Test & Assembly Centre (Utac), Global Testing Corp, Aztech Systems and Santak Holdings.

Based on a sample of 42 tech stocks and their closing prices last Thursday, BT found that some 61 per cent of the firms are trading at a historical price-earnings multiple of less than 15 - lower than the PE range of 16 to 18 times seen a few years ago, when many tech firms were in the recessionary stage after the bursting of the dotcom bubble. This is despite the fact that many tech firms have already posted modest growth and a recovery in earnings. Using the PE range of 16 to 18 times as a benchmark, it is clear that the Singapore tech sector is undervalued, as valuations are generally hovering at between 11 times and 15 times.

A look at the Singapore electronics equity index paints a similar picture. Despite clearer earnings visibility in the tech sector since 2004, the closing index value on Friday was down by over 20 per cent from that registered three years ago, while the Straits Times Index had doubled over the same period.

Given the sector's attractive prices, it is therefore not surprising that private equity firms Kohlberg Kravis Roberts (KKR) and Affinity Equity Partners had acquired MMI and First Engineering respectively. These private equity firms typically look for targets with stable cashflow, low gearing, healthy business and depressed valuations. Also, the targets are often small to mid-cap stocks.

Besides the private equity, the bargain hunters could also be strategic buyers that are looking to buy firms to expand either vertically or horizontally, or to penetrate a key segment like Venture's takeover in GES International last year.

SEMICONDUCTOR TARGETS

Generally, the volatile semiconductor cycle has led many investors to shun semicon stocks for fear of getting their hands burnt. However, this is less of a concern for private equity since its longer-term investment horizon of three to seven years allows them to ride out the boom-bust cycles.

In a report, DBS Vickers said that 'more deals are possible within the semicon sector because it is only a matter of time before today's lagging stock prices and valuations, owing to weak near term horizons, get re-rated when the expected upcycle swings by'. Besides, private equity firms have the financial resources to quickly buy over firms at depressed prices before restructuring them and then selling off at higher prices.

In this segment, Citigroup sees Utac as a strong M&A candidate, given 'its healthy operating cashflow and a balance sheet that has room for leverage'.

The research house notes that Utac is now a sizeable player, 'thanks to two well-integrated acquisitions and organic growth'. The firm was ranked fifth globally in terms of 2006 revenue - up from eighth a few years ago.

Also, DBS says that Utac's valuation is attractive at a price-to-book (P/B) of 1.4 times for 14 per cent return on equity (ROE) compared with STATS ChipPAC's P/B of 2 times for 6 per cent ROE. This is also lower than P/B of 2.7 for the semicon assembly and test sector as a whole.

Another chips tester that may be bought out is Global Testing. The firm, which provides wafer sorting and testing services to big names like Marvell, Taiwan Semiconductor Manufacturing (TSMC) and Nvidia, ended the week with a PE of 10.72 - lower than the average PE of 24.74 for its peer group. Its P/B of 1.21 is also lower than the industry's average figure.

As for Chartered Semiconductor, its silicon-on-insulator (SOI) wafer technology complements TSMC's bulk technology, thus making a TSMC's bid for the firm a possibility. Plus, the production of SOI wafers is projected to grow by a compound annual growth rate of 40 per cent over the next five years, as the product goes into the mainstream.

Likewise, industry buyers could find AEM Holdings a suitable target due to its attractive substrate business and relatively low PE, says DBS.

NON-SEMICON STOCKS

Besides chips, there's also much buyout interest in the component suppliers from sectors like plastic, PCB assembly and metal stamping. According to some analysts, the private equity deals for such stocks appear to be priced at PE of 15 and below, and some noted a possible interest in stocks with precision metals business.

Based on that criteria, Miyoshi Precision appears cheap with a PE of 11.42 on Friday, and this was also lower than the peer group average of 46.82. Another possible target is Santak which posted a PE of 6.18 times - lower than its comparable average of 12.42. The company generated operating cashflow of $4 million for its first half ended Dec 31, 2006 and cash and cash equivalents of $8 million at end-December. Among stocks in the hard disk drive (HDD) sector, DBS believes that Beyonics Technology may be attractive to strategic buyers as it is deeply undervalued on both P/B and sum-of-the-parts valuation basis.

Indeed, the firm provides a good fit for buyers like Nidec. 'With the recent acquisition of MMI by KKR, it makes sense for Nidec to buy Beyonics' HDD division for secured baseplate supply to reinforce its number one position in the HDD motor assembly business.'

Also of note is Aztech Systems - a provider of original design and electronics manufacturing services like PCB assembly and plastic injection. The stock is not expensive, given that its PE of 11.34 as of Friday was lower than the average PE of 123.88 in its peer group.

In summary, there is still a considerable number of cheap Singapore tech stocks in spite of their healthy cashflows. This should continue to draw interest from private equity and strategic buyers alike in the months ahead.