This article first appeared in The Edge Malaysia Weekly, on April 3 - 9, 2017.

AMID talk of consolidation in the semiconductor industry, D&O Green Technologies Bhd could be seen as an attractive target, considering the light-emitting diode (LED) packager’s unique position in the industry as one of the world’s leading independent packaging houses for the automotive LED segment.

The company — which is involved in the LED packaging process in the automotive, general lighting and backlight unit segments — is at the tail end of its plan to phase out its non-automotive businesses and divert its capacity to the lucrative automotive LED segment.

D&O director Yeow See Yuen says the company’s foray into the LED segment started with the setting up of Dominant Opto Technologies Sdn Bhd — now a 61.84% subsidiary of D&O — in 2001, a greenfield venture into the sector.

“At that time, Dominant was just an associate company of D&O because it was a greenfield start-up. We had an empty piece of land and no buildings, machinery or factory,” he tells The Edge in a recent interview.

What triggered the decision on the new venture was Avago Technologies Ltd (now known as Broadcom Ltd following the US$37 billion acquisition of Broadcom by Avago last year), which was a client of Omega Semiconductor Sdn Bhd.

Omega is a wholly-owned subsidiary of D&O that was involved in the contract manufacturing of lamps prior to the LED boom, which had formed the foundation for D&O’s listing in 2003.

“Avago recommended that we produce surface-mount device LEDs because they said that was the future. Traditional lamps were gradually being phased out due to their bulkiness and lack of flexibility in the design of modules,” says Yeow.

The group then built a plant at Batu Berendam, Melaka, and set out to build its own brand. Realising that the LED chips market was highly competitive — dominated by Taiwanese and Chinese chip manufacturers — the company decided to break into the automotive LED segment.

However, it was unaware that it was a tough industry to penetrate. Yeow says the barriers to entry for the automotive LED segment are high, due to lengthy qualification and gestation periods.

“It can take four to six years just to qualify for one player. After getting qualified, you would have to design your product to secure a design win and following that, wait for the commercial production of a vehicle model, which is usually about two to three years down the road.

“So we struggled. We slowly developed over the years and got ourselves approved as a supplier of automotive LEDs. The customer base kept expanding and we set up sales offices in Germany, South Korea, India, the US and China.

“We persevered until 2009, and then came the LED TV wave,” he says.

Riding the LED wave

In 2009, LED technology started to breach the mainstream. There was a boom in the application of LED technology to televisions as well as the general lighting segment, albeit at a slower pace.

D&O decided at the time to be a first mover in the LED TV and general lighting segments, considering that it was a new market with all players on an equal footing.

“So we started to produce for these segments, but we were not aware that these were very difficult industries. Price erosion is very steep in the consumer electronics segment,” Yeow says.

He says the continuous drop in TV prices would trickle down the entire supply chain. In 2010, D&O saw a loss of close to RM90 million, forcing it to reconsider its business strategy.

Around the same time, Philips Malaysia had entered the picture and approached D&O for the supply of LEDs for the general lighting segment. However, the segment also eventually saw pressured margins, driving D&O to wind down its general lighting business.

Yeow says margins for the non-automotive segment typically hover around 5%, compared with the automotive LED segment, which offers up to 25% in gross margins.

By the end of 2016, D&O had almost completely phased itself out of the general lighting business, while its automotive business had built a solid foundation.

Transitioning into a pure automotive LED packager

At the end of 2016, D&O had almost completed its transition from a multi-industry LED player to purely serving the automotive LED market.

At their peak, the non-automotive businesses accounted for more than 50% of the company’s annual revenue. By the fourth quarter of the financial year ended Dec 31, 2016 (4QFY2016), contribution from the non-automotive segment had dwindled to 5%.

Yeow expects the trend to continue this year, with annual sales contribution from the segment falling below 5%.

In 4QFY2016, D&O reported a 91% increase in net profit to RM3.93 million from RM2.06 million, on the back of top-line growth of 20% to RM128.64 million from RM106.96 million.

For FY2016, its unaudited net profit grew 12% to RM11.41 million from RM10.23 million a year earlier, while cumulative revenue was down slightly at RM430.1 million from RM433.11 million in FY2015.

Yeow highlights that the revenue contribution from the automotive segment grew almost 50% in FY2016. He expects the segment to continue growing at a compound annual growth rate of 20% to 30% over the next three to five years.

“With that, overall revenue this year should see some growth, but that would be partly mitigated by declining earnings from the non-automotive side as we continue to wind down that business. However, margins should remain stable,” he says.

According to Yeow, D&O’s automotive segment currently serves more than 110 customers, which makes the company attractive as even big companies — like Avago and Philips — had attempted and failed to venture into the challenging segment.

“We painstakingly built our own brand and we have now reached a pivotal point. Barring unforeseen circumstances, we think the worst is over and we have turned around.

“For the next three to five years, the growth outlook is great but at the same time, we will have to prepare ourselves for the next leap, which can only happen if we have stronger collaboration. We will need support and a stronger structure, as our current structure can only support limited growth,” he says.

In talks with several parties

Yeow reveals that several parties have approached D&O to discuss potential collaborations, but says no agreement or conclusion has been reached from the ongoing talks, adding that D&O’s doors are always open for discussion.

Rumours of a potential merger and acquisition exercise have spurred the market’s interest in the counter, driving D&O to close at an all-time high of 66.5 sen on March 17. Year to date, the counter has appreciated 108.33%, vastly outperforming the FBM KLCI’s 6.41% gain during the same period.

Looking at D&O’s valuations, however, the counter could appear expensive, with a trailing 12-month price-earnings ratio of 53.88 times, versus other semiconductor players such as Unisem Bhd (14.24 times) and Malaysian Pacific Industries Bhd (13.61 times).

However, Yeow stresses that D&O is different from the likes of Unisem. He says the value of the company is not based purely on its earnings and assets as D&O provides a platform for other companies to expand in the automotive LED business.

“Our value is in the platform as we are a window to the automotive world. The value of this company will be different in the eyes of different prospective buyers. It is not about how much our PER is — it doesn’t work that way.

“There is value in this business because we are not an original equipment manufacturer. We are an OBM manufacturer, an original brand manufacturer. We own the patents, the designs and the brand.

“We have been qualified as a supplier for most of the major automotive companies, and there are very few standalone companies like us in the world as most of our competitors are integrated players,” he says.

Yeow says the company is not in a hurry, adding that it will focus on developing its capabilities and capacity, especially as it is currently operating at near maximum capacity.

In January, the company completed the acquisition of a piece of land with a factory building near its facility in Melaka for RM11 million to facilitate its medium to long-term expansion plans.

Yeow says D&O intends to move its support offices to the new building and convert its current office space in the existing facility into production floor.

“We spent about RM55 million in capital expenditure last year and we will have a similar level of capex this year. We will have to convert our existing machines and purchase new machines as well. We are also increasing the automation of our processes,” says Yeow.

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