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Saturday, January 28, 2006

Oniontech @ 28.5 cts (Technology / Korea) 0 comments

Final Poll Results: 3:4

(P.S: Sorry for any disturbances the advertisements above may have caused you)

Main issues

1.IPO risk

2.Heavy dependence on major customer for recurring income stream

3.Contract-based income streams might decline

Mobile communication service providers have had rather dismal or nonchalant fortunes subsequent to their listing on the SGX; two examples being Unified Communications (Malaysia) which sank to the pits after a profit warning in its first year post-IPO, and Ace Achieve (China) which saw profits stagnate after IPO as well as operating cashflow being consistently negative.

Of course, I shall not over-generalise about this, but one thing cannot be overemphasised: companies typically list in a good operating year, so as to maximise market valuation and proceeds. That is why I am hesitant about most IPOs, coupled with the fact that proforma earnings often take liberties with financial sensibilities by including one-off or extrapolated earnings during the restructuring process (IPOs are normally preceded by restructuring of the group) that don't materialise in the first post-listing financial year.

Of course, I wouldn't think Oniontech would be as bad as Unified because the former has an established steady source of recurring income, which is its main business: the RBT, or ring-back tone service (known as Feelring) which it provides with LG Telecom as the customer. Based on the latest financial statements (FY04) in the IPO prospectus, Oniontech's RBT business with LG Telecom alone comprises 60% of its total revenue. There are several issues (negative) with this: firstly, such a strong dependence on one customer and on one segment (RBT) places the bargaining power on the customer's side; secondly, LG Telecom, though one of the big three mobile telco providers together with SK Telecom and KT Freetel, holds limited market share of ~15% compared to SK Telecom's ~50% and KTF's 30%, which in turn yields two potential problems: firstly one of limited growth leverage by Oniontech onto LG Telecom's limited customer base, and secondly one of industry consolidation (there had been some talk of KTF-LG Telecom merger) which might see service provider consolidation in favour of the acquiring company (ditto the Seagate-Maxtor merger's potential impact on their parts suppliers).

Indeed, in Oniontech's prospectus the expectation is for "total revenue from monthly subscription fees to increase in line with the increase in LGT’s subscriber base, coupled with the increased penetration rate of our RBT service with such subscribers". LGT's subscriber base is estimated at about 8% per annum looking at its latest financial statement, and given the highly mature and high penetration rate nature of the Korean market it is unlikely to grow much faster than that. As for the popularity of the ring-back tone service, Oniontech expect "revenue from downloads for our RBT service to remain relatively flat", reflecting plateauing popularity of this service (not surprising giving the fad-like nature of technology-driven consumer services and products).

So where's the growth going to come from? The other 40%? Oniontech has an agreement with technology giant NEC to develop RBT solutions to other countries which accounted for 27% of their revenue in FY04; however these are not revenue-sharing agreements (like with LGT), more like one-time subcontracting work, because Oniontech will only develop these RBT backend software solutions(eg. billing) and systems to NEC's customers and then exit the stage once it is done; future revenue streams accrue entirely to the customer. The company had implemented such a large-scale system under this agreement for a Guangdong costomer, GMCC, before the IPO, and in the IPO prospectus had projected that "we expect total revenue from overseas projects to decrease as the sizes of the new projects we have recently secured, or expect to secure, are unlikely to exceed the size of the RBT system we developed for GMCC". So there, there's the IPO revenue padding that I was talking about above.

Then there's the other 13% under content solutions which comprises mainly the mobile games that it develops for another customer, SK Telecom. That sounds quite promising, but buying the stock based on this segment is assuming too much execution risk given the hitherto non-core nature of this segment to Oniontech which means it is hardly a first-tier, or even second- or third-tier, games developer in the highly competitive South Korean market. One has to distinguish between core (RBT) and non-core (content solutions) segments.

Given these projections by none other than the company itself in its prospectus, I'm not even sure that it could show decent performance growth (revenue or growth) in its first IPO year.

As for that most important factor which relates stock market to business --- the valuation, Oniontech's post-IPO diluted earnings per share is S$0.021, which at today's share price implies PE of 13.5 times. There has been some comparison with another South Korean company listed on the NASDAQ which operates in a similiar space: Widerthan ( this company trades at 30 times trailing PE, and hence some argue that Oniontech is undervalued. However, in terms of customer base, revenue base, and segmental distribution, it is clear that Widerthan has stronger growth potential than Oniontech. Widerthan has a strategic relationship with SK Telecom, Korea's largest mobile communications provider, to develop mobile entertainment across a whole spectrum, not just RBT but also mobile games, music downloads, messaging and information services. It has exported its services to mobile entertainment solutions to "42 wireless carriers in 17 countries", countries like the US (now that's something), Taiwan, Southeast-Asia and India. Even Nokia has taken a stake in this company (some are going to interpret this as: if Nokia takes a stake in Widerthan, other MNCs might take a stake in Oniontech .... I wouldn't think this way). Revenue, at US$60M, is six times that of Oniontech's. It is trading in the world's most advanced technology-related share market, the NASDAQ -- that alone accords it higher valuations. Oniontech, at best, is a mid-sized player with its core strength in the domestic RBT market.

Another Sarin? Some compare it with the multi-bagger but other than the fact that the same investment firm, Vision Capital, has a stake in both (and also that both have odd names), I wouldn't think so. Sarin has a niche that positions it as a world leader in diamond technologies; Oniontech has a reasonable position in one technology area which has low barriers to entry, and unexciting growth in the medium term, as has been implied by the company.

(1) Oniontech IPO prospectus on SGX website




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