SINCE the implementation of direct market access (DMA) in the fourth quarter of 2012 with its TC Pro application for security houses, N2N Connect Bhd (fundamental: 1.45; valuation: 1.5) has seen its share price run strongly.

The group’s DMA application has been well implemented, with strong adoption. However, at nearly 35.9 times earnings, N2N will probably need more than earnings growth from its DMA platform to justify the lofty valuations. The group might have to rely on mergers and acquisitions (M&A) to drive further earnings growth.

Recall that last year, N2N took advantage of its strong share price performance to raise RM108 million through a private placement at 89 sen apiece. Notes to the group’s accounts show that it still has RM92.76 million remaining for M&A activities, although the cash is currently held in a unit trust —AmIncome — which is exempted from corporate tax and management fees.

The company’s warrant, N2N-WA, which was trading at a moderate discount of 7.14% to its mother share, is a cheaper way to buy into the stock. It also has plenty of life left, expiring only in August 2018. N2N-WA has a strike price of 32 sen and a one-to-one conversion ratio.

At their respective close of 84 sen and 46 sen last Wednesday, N2N had declined 20.9% from a recent high of RM1.062 on May 21, 2014, while N2N-WA had declined 40.3% from a peak of 77 sen on the same day.

While further upside may largely depend on the kind of deals it does, N2N still has net cash of 22.29 sen per share, or roughly 28.6% of the warrant’s exercised value (excluding dilution from warrant conversion).

One downside to the warrant is that the group has been paying dividends and buying back shares. For the year ended Dec 31, 2014, the group paid out dividends totalling 2.2 sen per share, or 94% of net profit. This is value destructive for warrant holders.

N2N had bought back an estimated 3.8 million shares in the past 12 months. At least the shares were bought back at a slightly lower price than the private placement.

In the meantime, with most potential clients already using its system, the group plans to sell more advanced features to its existing clients to sustain growth. The latter includes most of the major investment banks and brokerage houses.

N2N’s net profit rose 22.22% year on year to RM5.09 million for the three months ended Sept 30, 2014, while revenue climbed 13.63% to RM25.84 million. Interestingly, the group’s most recent quarterly results saw the slowest net profit growth of only 7%, even as it lost the low base effect in the preceding quarters.

This article first appeared in The Edge Malaysia Weekly, on February 9-15, 2015.

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