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Terry Gou's Hon Hai has always been investors' ultimate Apple proxy, but the latest spin-off from the world's largest contract manufacturer is as much about data centres and electric cars as it is about the forthcoming iPhone 8.
Pre-marketing began on Monday for an initial public offering of Hon Hai's connector business (plugs, jacks and connector leads), which should raise in the range of $300 million to $500 million based on initial estimates.
This is a far cry from the $1 billion Hon Hai hoped to raise when it first filed its application for FIT Hon Teng, formerly known as Foxconn Interconnect Technology, last summer. It subsequently launched pre-marketing the following October, but pulled the deal when it was unable to get the double-digit price-to-earnings ratio it wanted.
At the time, Hon Hai was trading around 10 times forward earnings. Since then, the stock has shot up, rising 30.05% year-to-date.
It is currently trading around 11.8 times 2017 earnings and 10.7 times 2018 earnings, whereas syndicate analysts have assigned FIT a fair value between 11 and 13 times 2017 earnings and 13 and 15 times 2018.
Key will be whether FIT can pierce its parent’s valuation and price closer to 13 times 2018 earnings and a $500 million IPO deal size.
Last autumn, investors baulked at a premium valuation because Hon Hai is a bigger and more liquid company. Market conditions were also not as strong.
This time round, market conditions are a lot more conducive. This means investors will be more willing to listen to arguments that Hon Hai’s larger size means FIT’s higher earnings profile will have little effect on its parent’s EPS numbers, but a big one on its own.
Data takes a bite out of Apple
The company also has a far better story to tell because it can show investors a couple of quarters of numbers incorporating its December 2015 acquisition of Nasdaq-listed Avago's fibre optic business.
The M&A deal has already changed FIT's sales mix and is key to a medium to longer-term diversification into the data centre business, which is shifting to a higher compound annual growth rate (CAGR). It also has a partnership with Tesla
“FIT is at an inflexion point and having another set of quarterly numbers to show investors helps to underline that,” said one banker. “It clearly shows the company is diversifying away from its former reliance on Apple.”
But this changing business model presents investors' with their main challenge valuing FIT. For over the near-term, much focus will be on how it can benefit from the likely iPhone 8 supercycle.
The iPhone 8, or X as rumours suggest it will be called, is being exclusively made by parent company Hon Hai. Analysts believe the latter may end up deriving half of its revenue and profits from Apple this year once iPhone 8 sales kick in following the mooted September launch date.
It is a highly symbolic year for Apple, marking the tenth anniversary of its game-changing smartphone. Unsurprisingly, rumours about the iPhone 8’s design changes are even more rife than normal.
A recent slip up by Wistron’s CEO suggests the phone will have inductive wireless charging, dispensing with the need for a connector and charger.
However, the model will still need a connector to other Apple devices and again this is believed to be Apple’s standard Lightning connector rather than the USB-C, which Android devices increasingly feature.
In 2016, FIT Hon Teng derived 43% of its sales from mobile devices followed by 28% from computers, 25% from communication infrastructure and the remainder from autos, industrial and medical. But communication infrastructure has shot up from 15% last year thanks to Avago.
And while the overall connector industry is forecast to grow by a 5% CAGR through to 2021, the data centre connector market is predicted to grow by 11.2% over the same period.
FIT has now become the world’s fourth largest connector company with a 5.1% market share, up from fifth last year.
Its biggest competitors, NYSE-listed TE Connectivity and Amphenol, trade at much higher multiples around 16 and 23 times forwards earnings thanks to strong cash generation, which has been ploughed into share buybacks and dividends.
Bankers said FIT has not yet finalised its cash management policy and a payout ratio will be fixed after canvassing investors over the course of the week.
Syndicate analysts are forecasting profits to increase to $194 million in 2017 and $230 million in 2018 resulting in a gross profit margin of 18.3% in 2017 and 18.7% in 2018. In 2016, the company recorded $168.5 million net profit and a gross margin of 17%.
The deal is on an accelerated timeframe with formal launch scheduled for next week and pricing on July 5.
The company is offering 15% of its enlarged share capital with a 90%/10% split between institutional and retail investors.
A clawback to 30% will kick in if the deal is between 15 and 30 times oversubscribed.
Joint global co-ordinators are: Bank of America Merrill Lynch, CICC and Credit Suisse.
