Sunright is the world’s largest independent provider of semiconductor test and burn-in services
Net cash forms 102.6% of its market cap
48.41% stake in KESM is valued at 33.5% higher than its market cap
Potential proxy to the shift to EVs
SOTP-based fair value estimate of S$0.43/share implies a potential downside of 4.1% from its last close
Sunright is the world’s largest independent provider of semiconductor test and burn-in services and a leading manufacturer of reliability test systems that serves 6 out of the 10 global major semiconductor manufacturers. It was co-founded in 1978 by its current CEO, Mr Samuel Lim Syn Soo, and listed on the SGX Mainboard in 1994.
It is made up of a 48.41% stake in KESM Industries Berhad (“KESM”) and 5 wholly-owned subsidiaries.
Sunright is led by its co-founder, Mr Samuel Lim Syn Soo who also serves as CEO of KESM. Its key management holds a combined 56.7% stake in Sunright thus, ensuring an alignment of interests with shareholders. Prior to the board reshuffle in February 2021 to facilitate retirements and a downsizing of the board from 6 to 5 directors, all directors served a minimum tenure of 27 years except for Mr Daniel Soh Chung Hian (Independent Non-Executive Director) who was appointed in Dec 2018. This could be a possible indication of sound corporate governance given the long board directorships. In addition, Ms Sandy Foo Fei Ying, a Partner of Rajah & Tann LLP and a member of its Executive Committee, was appointed as Independent Non-Executive Director in Feb 2021 to replace the outgoing board directors.
Sunright aims to be a one-stop source for all its customers’ outsourcing needs and thus, offers full turnkey services which include wafer sort, test, burn-in, mark, scan and drop ship.
Burn-In of Integrated Circuits
Burn-in is a semiconductor manufacturing process used to weed out potentially weak devices. The reliability of such components is critical to the performance of the finished products (i.e. cars, computers, phones).
After burn-in, a semiconductor device is tested electronically at different environmental temperatures to ensure that the performance characteristics of their devices meet usage specifications.
Sunright is actively expanding its testing capabilities through its development of system level test “SLT” activities with the expectation of progressively moving into the US$686.86b photonics market which includes laser diodes and optical sensors that have high requirements for reliability and thus, present a large opportunity for testing.
Burn-In Boards/Test Tooling
In FY7/20, Sunright produced 46 multi-layer boards with highly populated densities that are designed to be tested as it prepares to increase capacities for continuing strong growth opportunities in communications and network servers through FY7/21.
Parallel Test Equipment
In FY20, it re-designed its KX5 equipment to address modularity and expanded it to drive lower voltage/higher current applications. As a result, its interchangeability has improved which allows the KX series of systems to test a wider range of devices from IoT, 5G, AI to automotive, thus opening more revenue opportunities.
The global semiconductor market is expected to grow at a CAGR of 8.6% from US$452.3 billion in 2021 to US$803.2 billion in 2028 as the rise in global consumption of consumer electronic devices continues.
The industry is marked by sales cycles with up-cycles historically averaging 10-17 quarters followed by down-cycles of 4-6 quarters. According to Fundsupermart, the main driver of its cyclicality is over- and under-estimations in production causing either inventory buildup or depletion which leads to dips or rises in production respectively.
It is this very reason that chip producers shut down factories at the start of the pandemic presuming an extended period of low demand for chips, however, the exact opposite occurred as the work-from-home trend spurred an increase in consumption of consumer electronics. This led to the global chip shortage that has crippled supply chains and is only expected to end in 2022 according to Bain and Company.
As a tester, Sunright sits near the end of the semiconductor value chain and plays a vital role in ensuring the reliability of the product before being released. Given that on average, testing makes up a relatively small c. 2.0% of the total manufacturing cost of a semiconductor chip, we believe that customers of Sunright will not easily switch it out for a competitor given the high switching costs involved and the importance of having a good tester which Sunright is as seen by its long track record of working with the world's largest semiconductor manufacturers.
From FY7/18 to FY7/20, Sunright’s revenue declined 27.2% on lower volume for burn-in, testing and electronics manufacturing services (EMS) as a result of the US-China trade war that started in FY7/18, the 2019 semiconductor down-cycle where industry revenue declined by 11.9% YoY and the COVID-19 pandemic which caused a disruption in demand and supply of semiconductor chips which has now culminated in a global chip shortage. Looking forward, Sunright’s management expects a ‘gradual recovery’ of the group’s businesses.
Sunright generates revenue from 2 main sources - rendering of services and sale of goods. In FY7/20, Sunright generated 65.0% of revenue from the former, followed by 32.9% from the latter with interest and investment income making up the remaining 2.1% of revenue.
Sunright’s gross margin has remained relatively constant at ~ 77.0% from FY7/16 to FY7/20. However, both EBITDA and net income margin plunged sharply in FY7/19 as a result of the effects of operating leverage as revenue declined steeply and they remained depressed through FY7/20.
3. Cost Structure
Sunright’s cost structure has remained relatively stable over the years with a high proportion of fixed cost that caused it to suffer from the effects of operating leverage as revenue reversed in FY7/19.
4. Net Cash
As of 1HFY7/21, Sunright is in a net cash position with cash and short-term bank deposits forming 73.5% of current assets. It has a current and quick ratio of 4.9x and 4.6x respectively indicating strong short-term liquidity to weather the continued revenue pressure stemming from the chip shortage.
1. Sunright’s net cash exceeds its market cap
From 1HFY7/17 to 1HFY7/21, Sunright grew its net cash at a CAGR of 13.8% through consistent positive operations cash flow and a conservative dividend payout ratio that has not exceeded 25.0% in the past 5 FYs.
Despite a continued expansion in its net cash position, its share price is still down 11.8% from four years ago which has caused Sunright’s net cash to build up to 102.6% of its market cap. We outline below why we think this has not been priced in yet.
Lack of sell-side coverage
There is currently no sell-side coverage for Sunright which may have caused it to be hidden from both institutional and retail investors. As many investors rely on equity research reports for stock ideas, this could have led to the stock falling under the radar.
Classification of cash prevents Sunright from screening well
Sunright classifies cash and cash equivalents as cash at banks and on hand plus bank deposits with maturity three months or less. This thus excludes the majority of its cash held in bank deposits that mature in more than three months. As of 1HFY7/21, 64.2% of its total cash were held in bank deposits that mature in more than three months and thus, cash and cash equivalents made up ‘only’ 61.2% of its market cap, hence, Sunright does not screen as well as it should.
Low dividend yield
Sunright does not adopt a fixed dividend policy and has over the past 5 FYs, had a low dividend yield of below 1.0% as a result of its low payout ratio. This disincentivizes dividend-focused investors from investing in Sunright.
2. Mispricing presents an arbitrage opportunity
KESM, together with its subsidiaries, provides burn-in and test services as well as EMS mainly for the automotive sector where it serves 5 of the top 10 automotive semiconductor manufacturers. It was founded in 1978 and is headquartered in Malaysia with clients mainly from Malaysia and China. It is listed on the Main Market of Bursa Malaysia Securities Berhad and is a 48.41%-owned subsidiary of Sunright.
In FY7/20, KESM contributed 68.2% to Sunright’s topline and this figure is projected to increase as global automotive sales gradually recover from the chip shortage and testing volume ramps up.
At its last close of MYR 11.00 per share, KESM’s market cap is S$152.6m, which means that Sunright’s 48.41% stake in KESM is worth S$73.8m. On the other hand, at S$0.45, Sunright’s market cap is only S$55.3m. Therefore, the residual market cap is a negative S$18.5m, thus implying that the market is pricing in a negative 25.1% discount to the according value of Sunright’s 48.41% stake in KESM as well as zero value to Sunright’s (ex-KESM Stake) net cash of S$24.6m and other testing/product subsidiaries. Hence, we believe Sunright is mispriced and presents an arbitrage opportunity should the market valuation of KESM hold above its current value.
However, there is the risk that KESM may be overvalued which we will dive into under the Valuation section.
3. Proxy to the shift to electric vehicles (EVs)
According to Canalys, global EV sales are expected to grow at a CAGR of c. 27.5% from 2021 to 2030, and capture c. 48.0% of total new car sales in 2030.
This benefits KESM as conventional cars contain an average of c. US$330.0 value of semiconductor content while hybrid electric cars can contain up to c. US$1,000.0 to US$3,500.0 due to increased autonomous, connected and electric mobility capabilities. As a result of the increased semiconductor content, testing costs for EV semiconductors are expected to be significantly higher which could boost the topline and bottom-line of the automotive-focused KESM as its clients shift to produce more EVs.
We used a sum-of-the-parts (SOTP) method to determine Sunright’s valuation.
Given that KESM's balance sheet is consolidated into Sunright's balance sheet, we stripped out the entire KESM net cash amount which gave us a value of S$24.6m and implies a net cash of S$0.199/share.
48.41% Stake in KESM
Given that KESM’s EBITDA, EBIT and Net Income margins were lower than the median figure, we applied the 25th percentile NTM P/E of 22.7x to the NTM street estimate. This gives us a market cap of S$85.1m which implies an ex-net cash NTM P/E of 4.8x and represents a 44.3% discount from KESM’s current market valuation. Thus, we value Sunright’s 48.41% stake at S$41.2m or S$0.336/share.
We opine that this is a fair valuation and could be revised upwards should KESM’s testing volume recover on the easing of the global chip shortage.
We valued Sunright’s (ex-KESM Stake) investment securities based on its 1HFY7/21 figure which gives us S$0.5m or S$0.004/share.
Sunright’s other business segments
Given the uncertainty regarding the profitability of Sunright’s other business segments and their small net income proportion relative to KESM, we did not ascribe any valuation to them to err on the side of caution.
Holding company discount
We applied a holding company discount of 10.0%.
We applied an illiquidity discount of 10.0% due to the relatively low average daily trading volume (i.e. 22.1k during the 3-month period) which could cause large bid-ask spreads.
This gives us a fair value estimate of S$53.0m or S$0.43/share which implies a potential 4.1% downside from its last closing price of S$0.45/share.
1. Revenue concentration risk
Sunright has 3 key customers who accounted for c. 70.8% of its FY7/20 revenue and thus, Sunright will be significantly affected should it lose any of these customers. However, given the high switching costs involved should its customers choose another test provider and Sunright’s long track record in the industry, we believe it will be an unlikely scenario. In addition, its subsidiary, KESM, commented on this risk in its AR20, stating that it expects ‘our service to these customers to continue in the foreseeable future since we are well integrated into their supply chain’.
2. Stock illiquidity due to low market cap
Given its small market cap of S$55.3m, Sunright’s stock suffers from poor liquidity potentially causing large bid-ask spreads, and thus, we applied an illiquidity discount in our valuation.
1. Potential privatisation
Sunright’s CEO holds a 54.9% stake, with percentage free float at 36.4%. Given that it is in a net cash position and holds a 48.41% stake in KESM that at market valuation is greater than its market cap, we believe Sunright could be an attractive target for privatisation.
2. Increased sell-side coverage
As touched upon in Investment Merit 1, we believe an initiation of coverage on Sunright will drive investors to this obscure small-cap stock which could have a positive impact on its stock price.
3. Easing of global chip shortage
According to AlixPartners, the chip shortage will cause 3.9 million vehicles or 4.6% of the 84.6 million vehicles projected in total production for 2021 to be lost. As a result, KESM has stated that this “may momentarily impact a smooth recovery of its businesses” as burn-in and testing volume remain low. Thus, an earlier than expected easing of the global chip shortage could boost its topline and bottom-line as auto sales recover on increased supply of production inputs.
4. Share buyback
Given Sunright’s strong net cash position, we believe it is well-able to buy back shares which would send a strong signal to the market that the stock is undervalued and also potentially benefit long-term shareholder value.
Given that we are in the midst of an unprecedented global chip shortage, we expect Sunright’s short to mid-term earnings to be weak. Nevertheless, we will be monitoring for the materialisation of any catalysts which could present a potentially interesting arbitrage opportunity.
Thanks for reading,
Disclaimer: I am long Sunright (SGX:S71) at an average price of S$0.45. This article is not an investment (buy/hold/sell or otherwise) recommendation, this is only for educational and discussion purposes. This article is not tailored to the specific circumstances of any reader. I/we/The Snowball do/does not purport to be in the business of providing financial advice and the contents of the article should not be regarded as such. Cover Photo by Louis Reed on Unsplash
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