Cowell e Holdings (1415.HK): Participate

IPO - The company is a manufacturer of camera modules for smartphones and tablets with production facilities in Guangdong. The company has 5% global market share, mainly supplying its products to Apple, and LG Electronics which account for 78% and 19% of revenues respectively. Firm has roots in Korea and was listed on the KOSDAQ from 2008 to 2011 before being privatized. Current shareholders are the Chairman (50%) and private equity group Hahn & Co. (50%).

Pricing and Recommendation:

The IPO pricing range of HK$4.00-5.75/share puts the expected market cap range for Cowell at HK$3.3-4.8bn (US$430-620m) and implied 2014 P/E of 8.1X-11.6X. Peer group averaging 16.1X and Hong Kong peer Sunny Optical is trading at 21.5X. Firm will be viewed mainly as an Apple component supplier. The company is offering 208m shares (40% primary), representing 25% of the enlarged capital. The majority of the proceeds will be used to enhance existing flip-chip and chip-on-board (COB) camera module production lines and repay existing debt. We recommend investors participate in the IPO.

Investment Positives:

Established Camera Module Supplier - Firm has already established itself as an approved supplier to LG, Samsung and Apple. This translates into lower spend required for marketing and sales. Stringent quality control and track record are barriers to entry for competitors. The firm has strengthened its relationship with its customers, resulting in increased volumes and expanded supply of product lines to existing customers.

High-End R&D - Cowell’s 360 engineers working closely with its customers in the design phases of mobile products. Company began supplying Apple with front facing fixed-focus camera modules and then graduated to supplying COB back facing camera modules in 2009. In 2012, Cowell started providing flip-chip modules. Company notes that its flip-chip technology and low cost production are key advantages. Flip-chip production process produces smaller physical footprint camera module, which is more desirable and results in higher ASP and margins over COB products. The firm spent US$21.5m in capex in 2014 to purchase equipment used in the production of flip-chip camera modules.

Stable Growth Drivers - According to IBS reports, camera module industry was US$16.4bn in 2013 and is expected to reach US$34.4bn by 2020, representing 11.2% CAGR. Demand is mainly from mobile devices but there is also opportunity in other uses including security cameras, automotive and medical imaging. Cowell has agreed to supply 13megapixel modules to LG Electronics starting in 3Q15. The higher megapixel modules should result in better ASP and margins. Production line utilization rates are below 60% so there is room to support growth near term without significant capital investment.

Risks:

Apple’s Draconian Controls - Supply contracts include “step-in” rights for Apple and material amounts of remediation if the company breaches its contract terms. Apple also designates 23 of the 38 suppliers that Cowell is allowed to source from. Furthermore, production equipment is loaned to Cowell by Apple mainly for COB products and is restricted to the production of Apple products.

Replacement Demand - Growth in Flip-Chip is not mutually exclusive but rather replacing some demand from COB products. Future growth relies on ability to upgrade manufacturing to new technologies. The COB production process is not entirely interchangeable with the Flip-Chip production process. Changes in future camera module production could impact the firm’s ability to remain competitive.

High Gearing to Changes in Component Costs - Firm estimates a 5% increase in component costs would have resulted in profits declining by 60% in 2013.