Silverlake Axis

UOBKayhian on 22 Mar 2013

We initiate coverage on Silverlake Axis (SAL)with a BUY recommendation and a street-high, DCF-based target price of S$0.91, implying a 45.6% upside from the current price. SAL’s dominance in the Southeast Asia (SEA) market will enable it to ride the positive trends in Asia Pacific’s banking sector. Its strong financials are backed by visible earnings, a recurrent revenue stream and superior margins. Healthy cash flows (FCF of 3.0-4.3 S cents/ share) will support its dividend distributions and open up the potential for earnings-accretive M&As. We also note the possibility of a re-rating should its Chinese associate successfully complete its Shenzhen listing.

·Industry stronghold with sticky client base.SAL is a provider of banking IT solutions and services with a 100% execution track record that has given it market leadership in SEA. It currently enjoys strong loyalty from over 40% of the top 20 largest banks in the region. We expect SAL to maintain this dominance in the high barrier-to-entry IT software and services industry as banks continue to rely on their preferred IT vendors. SAL will also benefit from the financial services industry’s increasing investment in IT infrastructure.

·Visible earnings and a growing recurrent stream. An existing orderbook of about RM400m gives SAL earnings visibility until FY14. Maintenance & enhancement services revenue continues to build up as existing and new clients avail of necessary maintenance works and upgrades. We expect this segment to be resilient and to grow at a 27.8% CAGR over FY13-15.

·Superior margins and ROE on cost competitiveness. SAL’s operating margins are at least 10ppts higher than its global peers, which we attribute to its lower wage cost (12% of revenue vs 40-50% for its peers). SAL’s net margins are above 40% and we project its bottom line to grow at a 3-year CAGR of 16.3%. As a result, its ROE of 46-58% is also superior to its peers.

·Cash-generative business to support decent yields. We project SAL’s operating cash flow to hit RM200m by FY14 with cash yields of 5.2-7.2% in FY13-15. Looking ahead, we think SAL could easily sustain its 60% payout in FY12 and forecast dividends of 2.0-2.4 S cents/share in FY13-15. Capital spending is mostly for software development, which amounts to RM10m annually.

·Opportunities for earnings-accretive M&As.Earlier this month SAL announced the potential acquisition of an 80% stake in Merimen Ventures (Merimen), an internet-based solutions provider for the insurance industry in Asia Pacific and Middle Eastand North Africa (MENA) region. We expect this to form another source of recurring income for SAL. We view this and future similar strategies positively as it would yield synergies that could further unlock SAL’s value.

·Potential re-rating on Chinese associate’s listing. SAL intends to leverage on its current presence in China through a Shenzhen listing of its 27% associate, Global InfoTech Co. (GIT). We see a potential upside to our fair value estimate givenChina’s scale (project sizes 4-5x bigger) and underpenetrated market (90% of IT systems are still in-house). We estimate that should GIT successfully scale up its business, its earnings could double by FY15.

·Key risks include a) a reliance on skilled labour, b) technical and execution risk, and c) foreign exchange risk.