Thursday 28 Mar 2024
By
main news image
This article first appeared in The Edge Malaysia Weekly, on February 13 - 19, 2017.

 

N2N Connect Bhd’s huge cash surplus has been both a source of strength and a point for criticism. At its peak in 1Q2016, N2N had RM108.6 million in net cash, prompting many investors to question if the company could extract more value from its balance sheet.

To be fair, N2N pays out an annual dividend of two sen per share, which is over 80% of earnings. But this has been priced in, with the company’s shares valued at a dividend yield of less than 3%. Frequent share buybacks have helped boost earnings per share in recent years, but its shareholders still expect more value from the company.

Hence, it should have been a catalyst when N2N announced the US$20.6 million (RM91.38 million) acquisition of Hong Kong-based AFE Solutions Ltd last October. But, N2N’s share price continued to fall, closing at a 52-year low of 63.5 sen on Jan 24, down 37.4% from a record high of RM1.02 a year earlier.

The very next day, the company bought back 560,000 shares at 65 sen apiece, kick-starting an 18% rebound in its share price. The stock closed at 75 sen last Wednesday.

At this level, N2N is valued at 26.8 times FY2016 earnings. In contrast, the stock used to command valuations exceeding 52 times. Against this backdrop, is there more upside for N2N?

That depends on whether the company can meet expectations for earnings growth. In turn, this will depend largely on how successfully it can consolidate AFE this year.

Like N2N, AFE is a data and trading solutions provider. Servicing about 600 clients and over 8,000 information terminals, it is estimated to have the largest market share in Hong Kong’s mid-tier brokers’ space.

The only catch is that AFE is loss-making.

According to a circular to its shareholders, AFE booked a net loss of HK$6.2 million (RM3.54 million) in FY2015 ended Dec 31, compared to a net profit of HK$9.66 million in FY2014. Revenue fell from HK$114.92 million to HK$112.96 million in the same period.

“For FY2016, we should be on course to meet earnings expectations — continuing the current growth trajectory that we are on. For FY2017, however, earnings will likely be flat as we consolidate AFE and absorb one-off costs. However, by FY2018, we should begin to see strong contributions from AFE to our bottom line,” explains N2N founder and CEO Andrew Tiang.

He points out that there are a lot of synergistic cost-saving exercises that N2N can undertake with AFE to turn the latter around.

“Every dollar we save goes directly to the bottom line and there is plenty of synergy we can easily unlock. For example, N2N and AFE have overlapping servers, hosting and content licensing fees. We need only one licence, so we can reduce costs there. We can also move some of the operations to Malaysia, where the costs are lower,” says Tiang.

Of AFE’s costs of HK$100.35 million incurred in FY2015, the top three expense items were employee benefits (37%), subscription costs (24%) and exchange fees (21%).

It is interesting to note that AFE’s net loss in FY2015 was largely due to higher losses and impairments of HK$7.37 million and HK$8.16 million respectively, attributable to a Thailand-based associate — Bisnews AFE (Thailand) Ltd.

In contrast, Bisnews only booked a loss of HK$5.14 million in FY2014 with no impairments. Without the massive write-down, AFE would have been profitable in FY2015. In fact, its operating profit remained relatively flat during the period, down 1.8% year on year to HK$17.11 million.

“When acquiring AFE, the main thing we were looking for was its market share and domain knowledge, not its systems or assets. AFE has the largest market share in the mid-tier [space] — the traditional retail brokerages and information services terminals where the margins are strongest,” explains Tiang.

The top-tier segment includes the institutional brokerages that have high transaction value but a relatively low number of users and low transaction volume. The bottom or third-tier segment is mostly the, “mom-and-pop operations run by a handful of people with 10 to 20 clients; mostly to manage their family’s investments”, says Tiang.

“When acquiring AFE, we considered the cost of acquiring a similar footprint ourselves by competing in the same market. The acquisition is not only cheaper but it also saves us time.”

He adds that the acquisition will not deplete N2N’s cash pile. “We are looking into various financing proposals and may resort to some borrowings to hedge against forex exposure. We are pledging our ringgit to help reduce the interest expense, even though the rate in Hong Kong is already quite low. We will try to strike the right balance so that the interest payments will not take up all of AFE’s earnings. Remember, like N2N, AFE has virtually no borrowings on its balance sheet.”

In short, N2N’s gross gearing will rise, but its net gearing will increase by a smaller quantum.

There is also a growth perspective to explore in Hong Kong. Tiang says apart from expanding market share, he wants to push multi-market trading to AFE’s clients in Hong Kong.

“Right now, the Hong Kong market is quite saturated. So, a lot of investors are beginning to look overseas. Our system will allow them to trade seamlessly in the US, Europe, the Middle East, Singapore, Malaysia, Indonesia, the Philippines and Thailand, besides China and Hong Kong. We are also looking to include Australia and Japan,” he says.

Only time will tell if N2N’s acquisition will pay off. But expect the group’s top line to balloon by about RM60 million annually to over RM100 million.

“Today, about 70% of our revenue comes from Malaysia. But once this acquisition is completed, we expect about 65% to come from overseas operations,” says Tiang.

Recall that N2N has over 70% market share in supplying financial information and trading services to brokerages in Malaysia. It is a relatively recession-proof business that generates steady recurring cash flow — a key reason N2N was able to garner such high valuations in the past.

Last year, however, there was an interesting development in the industry — N2N’s long-time rival Excel Force MSC Bhd saw its founder Jeff Wang sell his stake in the company to MyEG Services Bhd managing director and co-founder Wong Thean Soon.

The talk in the market is that Wong is eager to take back some market share from N2N.

But Tiang brushes off such concerns. “We have just renewed a five-year contract with most of our clients, so domestic earnings should see steady growth while we focus on expanding regionally. I am aware that some competitors are attempting to offer substantial discounts to win over some of our clients, but this is not an industry where you can start a price war. ”

 

 

 

Save by subscribing to us for your print and/or digital copy.

P/S: The Edge is also available on Apple's AppStore and Androids' Google Play.

      Print
      Text Size
      Share