Description

For investors looking for a port in the storm, we think Stark Technology ticks a lot of boxes. It is the dominant System Integrator (SI) in Taiwan with a sticky customer base of blue-chips. It has a history of steadily growing its top line and margins and is committed to a 90% payout ratio (6% dividend yield at current price) in TWD which is backed by one of the strongest forex reserve in the world.

Stark Technology is the largest domestic system integrator in Taiwan. For anyone who has already invested in the space, the company, which does a good job of explaining in English its technology supplier relationships and industry verticals composition, should be pretty straightforward to understand.

I will therefore focus on the specificities of the Taiwanese market and Stark Tech’s positioning in it.

The revenues increase since 2018 has been driven by Taiwan’s government investment in digital infrastructure, anti-money laundering solutions requirements from the financial sector and increased demand from the semiconductors fabless industry.  With stable 25% Gross Margins, the team of founders and equitized employees has benefited from operating leverage while keeping a keen eye on costs to reach 10% EBIT margins. This has driven a healthy 20% earnings CAGR since 2017.

The company has a high customer retention or renewal rate of 90%, showing some signs of a high-switching costs moat. The service and maintenance basis has 50% gross margins, while hardware delivery delivers 15% margins. As such, service and maintenance contributes more than half of the gross profits.

Interestingly, we found out that 20 to 30% of revenues are associated with cyber security, across industry verticals. That business line is growing rapidly given the growing requirements for both corporate and government sectors to harden their security and for broader regulatory push to offer stronger consumer and IP protection. Although the vast majority of the deployed software and hardware solutions are sourced from the US, we get the sense that there is a strong preference for its delivery and maintenance to be carried out by local vendors, providing a nice barrier to entry. The company has also developed its own point cybersecurity solutions, which it is trying to market across its customer base.

Although anyone who has spent time in Taiwan can vet the very high quality of its technical education, the average salary of a junior IT engineer is only about USD3,000 per month, a fraction of salaries in the US and even competitive within a regional context.

The corporate culture is very healthy and shareholders friendly. The headquarters of the company in Hsinchu, an hour south of Taipei, is one of the most frugal we have seen in Asia. We also like the fact that the 150+ sales representatives are given Gross Margins- rather than Revenue-based sales targets.

The seven original  founders have distributed some of their shares prior to the IPO. There is therefore no dominant shareholder and decisions seem to be taken by  consensus among the broader team. The company’s executive team took home less than USD1M last year, with most of their income coming from the company’s dividend payments.

We wish that Taiwanese taxation of retained earnings would be adopted across the rest of Asia. The results are very high dividend payout ratio and efficient balance sheets. Even among that very favorable backdrop, Stark Tech’s consistent 90% dividend payout ratio stands out.

The company trades at 11 x EV/EBIT and 14 x PE and yields 5.7%. It is on the higher end of our valuation range but we think that its earnings growth and stability and corporate governance more than compensate for it.

Catalyst

There is no particular catalyst in views, but we think that the inventory build-up linked to associated hardware which is highly correlated to future revenue growth points to continued top line and hence earning growth.

Risks:

Geopolitical: we think that it is very unlikely that China will attack Taiwan, but it has to be one of the main perceived risks. 

There is otherwise a lot to like about investing in Taiwan. There is a quasi-peg to the USD but with a much better financial position on a NIIP basis. Overall corporate governance is very good and the rule of law solid. Put another away, it strikes us as a great way to indirectly invest in China’s growth, with much less risk.

Technology obsolescence: we think that Stark Tech has shown enough flexibility in selecting up-and-coming technologies for its roster of long-term clients to be quasi-immune to this risk.