Description

Bizlink 貿聯 (3665 TT) – Long Recommendation (2020/03/25) 

Situation

BizLink is an enterprise-focused manufacturer of cables and connectors. After beginning in commoditized PC cables (1996) and surviving the tech crash, BizLink managed to diversify its product offering and onboard new customers from industrial, medical, EV, and enterprise-IT segments. Recently, new product offerings related to USB type-C cable redesigns contributed to a tripling of operating profits between 2015 and 2019.

 Since January, BizLink’s share price is down -35% reflecting concerns related to COVID 19. While the final effects on global demand cannot yet be determined, the year to date has already seen BizLink’s China-based assembly lines returning to full capacity. On the demand side, the company is currently seeing a pick-up in order volumes from key customers including Dell and Amazon, responding to demands for work-from-home offices and data centers, respectively. Semiconductor capital equipment and EV[1] demand are similarly robust. 

BizLink is trading at close to 5-year lows on nearly every measure, with an NTM P/E of 9x and a 6% dividend yield.

But the company’s long-term prospects are considerably better than the market appears to believe: 

·         Relationships with customers Dell, HP and Tesla span 15+ years and provide revenue stability. BizLink’s in-house design and manufacturing facilities contributed to expanding order books with these customers, who value the company’s ability to keep up with rapidly changing product specifications and reroute production production from China to Malaysia to Mexico or Serbia, if necessary.

·         Management has continually invested in capabilities for high barrier products. The company’s solutions in high-speed server cables and a pending acquisition of an advanced wire harness company are two examples.

·         BizLink enjoys a strong cash cushion after its December rights offering ($80M), and extension of its $100M convertible bond through December 2024.

Company and Industry Backdrop

The market for cables and connectors is extremely fragmented because of the sector-specific customization. Tesla uses BizLink’s harnesses in its vehicles to transmit information between the battery management system (BMS) and battery packs to ensure a safe battery operating environment. This is completely different from high signal-fidelity optical fiber cords used in MRI machines, or junction boxes on solar panels that transfer power while protecting against overheating. 

Segment revenues: IT 46%, Electrical Appliance 25%, Automobile 16%, Medical 5%, Industrial 4%, Telecom 2%, Other 2%.

Connector Industry

Connector customers tend to care most about product reliability and durability, then cost savings and reduced design turn-around time. In general, enterprise customers tend not to be price-sensitive when volume numbers are small, as connectors costs are typically 1% or less of product price (e.g. a $300 BMS cable is 0.5% of the $75,000 cost on a Model S). BizLink’s segment gross margins range from industrial/ automotive/ medical at the high end at 24-28%, and electrical appliances at the low end with 17-19%, with IT in between (21-23%). Management strongly believes they can improve margins further by continuing to shift sales toward higher-complexity, higher-margin products. 

Because of the considerable risk associated with supply chain changes, top customers have been with the company for >15 years. The flip side is that it can take years for a “tier 2” player (anyone outside of TE Connectivity, Molex, Amphenol) to crack the supply chain of established automobile and industrial customers.

On different operating models

In the table below, industry leaders TE and Amphenol in the US enjoy operating margins as high as 20% (vs BizLink’s 9.7%) – aided by mass production efficiencies and favorable exposure to clients in aerospace, defense, and high-end automobile components. Smaller suppliers generate EBIT margins of 8-15% EBIT but have step function growth opportunity (see BizLink and Sinbon in the last 3 years). Some smaller suppliers have taken receivables’ risk in order to grow particularly with high revenue exposure to Chinese or auto OE customers, and now show average receivable days of over 100 days. 

In contrast to US-based leaders TE and Amphenol, BizLink’s core capability is its new product design (NPI) and redesign capabilities that allow customers to enjoy flexibility and efficiency when engineering next-generation products. BizLink’s vertical integration offers customers customized design services on high-mix, low volume orders. As a result, its EBIT margin should not approach 20s% under its current product portfolio.

Figure: Connector Suppliers

Management Quality

BizLink’s largest shareholders are co-founders and husband-wife team, Hwa Tse-Liang and Inru Kuo, who serve as Chairman and director/ general manager, respectively, and together control close to 17% of shares. 

BizLink has historically passed on revenue opportunities that did not meet their requirement of 75 of fewer days-receivable. Current customer base skews toward European and North American blue-chips (Dell, HP, Tesla, Dyson, TI, GE Healthcare). In contrast, cable manufacturers such as Deren, Hulane, Sinbon have benefitted from the explosive growth of Chinese EV upstarts and wind farm projects but accepted significantly higher levels of receivable risk. 

In 2016, BizLink began pursuing M&A, starting with the $3M acquisition of Joh Yeh (specialty harness manufacturer serving Japanese auto OEMs) and followed this in 2017 with a €50M acquisition of Leoni’s then-struggling electrical appliances (EA) business unit, which traded off near-term profitability for access to a diversified base of European appliance makers. The latest acquisition of Singapore-based Speedy Industrial Supplies increases BizLink’s vertically integrated capabilities and brought new customers in industrial and medical markets. 

Related to this inorganic growth has been the issuance of equity and convertible bonds for growth investments. In December, BizLink extended the maturity of its $100M zero-coupon convertible bond to 2024 and raised $80M through a rights offering. Management remarks point to interesting M&A targets in US-markets, but this opportunity must be balanced against share dilution and integration risks.

Growth Forecast

Existing contracts can sustain 6-10% top line growth for the next few years

The largest contributor to revenue is mid to high-end PC docking stations for commercial and select high-end consumer use (roughly 37% of 2019 revenue). Commercial docking station sales have diverged positively from declining PC sales due to the convergence of slim-form workplace laptops with fewer ports that nevertheless are being used to drive multiple monitors. The result is that more computing capabilities (graphics, power control, cooling solutions) are being pushed into office docking stations. 

Docking station sales took off between 2016 and 2018 as the industry migrated toward USB-C as a new standard, leading to BizLink’s 44% and 57% IT sales growth in 2017 and 2018. Over the next few years, this can be expected to stay grow 5-10% with more routine product updates. 

A second source of growth is from existing auto customers - Tesla, Polaris, and Thermo King. For its largest auto customer, Tesla, BizLink has been sole supplier of BMS-cables since 2005. Roughly 25% of Tesla revenue comes from energy storage Powerwall and high-speed charging cables. With Tesla’s Model Y, Shanghai factory, and European Gigafactory all coming up over the next two years, the Tesla relationship continues to support growth. Bearish projected Tesla unit growth (Credit Suisse, sell recommendation) is factored into the model base case.

Emerging Auto opportunity

BizLink’s auto customer base has been relatively unchanged over the last 10 years owing to management’s working capital discipline and the inherent conservatism of automobile supply chains. In the last few quarters, BizLink announced an agreement with a Chinese EV SUV-manufacturer, as well as a rear camera contract for Fiat Chrysler. These announcements, along with the 2016 acquisition of auto harness manufacturer, point to opportunistic expansion within this high margin segment.

Emerging Opportunity in High-speed server Cable

Within server equipment cables, high end direct attach cables (DAC) capable of 100-500 Gb/ second transmission are growing their share relative to more active optical cables (AOCs), as transmission capabilities of the former have caught up. On this comparison, Grandview Research estimates that the direct attach cable market will grow to $13.3Bn by 2025 from $1.2Bn in 2017.

BizLink’s 2018/2019 offerings in next-generation power standards (200-400G/ second cables) for US style server racks puts sees BizLink trying to take share from industry leaders Molex and TE. Two advantages:

1) the server market overlaps well with BizLink’s existing IT customers; its two largest IT customers, Dell and HP, also account for 38% of the worldwide server market (IDC)

2) BizLink’s strength is providing customized, low-volume product specs can be useful in large data center deployments that may not fit neatly within a few standardized cable lengths

Valuation

The DCF base case indicates that existing business opportunities (docking stations and EV) are not fully discounted into the current valuation. All cases assume an additional 2% opex burden revenue related to COVID supply chain disruptions, and 9.5% dilution from 2024 convertible bond in the next two years.

·         Base case output points to an annualized revenue growth rate of 6.9% from through 2025

·         Bear case assumes a sharp drop off in IT revenues in 2021 and 2022 of -50% and -30%

·         Upside case assumes modest success in the two upside opportunities detailed above: 1% market share in server cable opportunity, and future automobile revenues equivalent to 25% of the Tesla opportunity by 2025.

On a weighted probability basis (60% weight to base case, 20% weight each to bear and upside cases), this yields a fair value of 215 NTD/ share, 59% above the current price.

As a check for conservatism, earnings-based valuation assuming 2021 P/E of 13.5x bear case; 15x base case; 17x upside case yield meaningfully higher valuations.

Risks

·         Dilution from the conversion of present and future ECBs.

·         Margin sensitivity to commodity price movements

·         High customer concentration: the top 10 customers accounted for 55% of 2018 sales

·         Incremental trade war-related costs.

o    In 2018, the trade war led to some order declines. BizLink has responded by relocating facilities in MA (dongles, auto), MX (auto), TW – through 2018 and 2019. Total China to US sales exposure before adjustment can be estimated around 15-16%

·         BizLink’s short-term stock price can be volatile with Tesla’s earning results, as BizLink is perceived as depedent on Tesla business, even though related revenue are only 8% of the total.

Catalyst

·         New customer wins in automobile or server cables

·         USD 100M convertible issuance creates positive opportunity for tuck-in acquisitions.

·         Further margin improvement from product mix improvements within its Electrical Appliances division