Investment Highlights

• We keep our BUY recommendation on N2N Connect (N2N) but cut our FY18F-FY20F forecasts by 10%–32%, due to lower market velocity and higher tax rate assumptions. We also reduce our fair value to RM1.35/share (previously RM1.50/share), pegged to an unchanged FY19F PE of 25x.

• N2N’s 9MFY18 core net profit of RM9.4mil (-25% YoY) came in below expectation, accounting for 47% of our full-year forecast and 39% of full-year consensus estimates.

• 3QFY18 core profit came in at RM2.3mil, representing a drop of 42% YoY and 17% QoQ. The decline was mainly attributable to the slowdown in the local equity market, which was impacted by 14th general election in May and to a certain extent, global market uncertainties.

• This is evident in the 8% QoQ fall in the local market trading volume, while 3QFY18 market velocity dropped to 30%. As a comparison, Q2FY18 and Q1FY18 recorded a market velocity of 36% and 35% respectively.

• Higher tax rate for the quarter has also taken a toll on earnings, with the bulk of it accounting for previous year’s unpaid tax. After the tax penalty and additional tax charge from the Inland Revenue Board (IRB) in July 2018, the company had to revisit prior year’s tax assessment based on a new tax treatment. As a result, the effective tax rate rose to 34% from an earlier estimate of 6% for FY18F. However, management guided this will not recur in the subsequent quarter.

• We believe the long-term prospects of N2N are still intact given its potential strategic collaboration with SBI Holdings (SBI). Recall that the two parties intend to develop a blockchain-enabled platform to digitalise the trading of multiple financial instruments in one venue, including equities, derivatives, currencies, etc.

• In regards to N2N’s near-term growth, we expect earnings to be driven by an industry-wide replacement of back office systems (BOS). We understand that most brokers’ BOS are 15-25 years old and a replacement is long overdue. The increasing complexity of trading procedures, such as the recent introduction of short-selling, requires a more advanced BOS, thereby necessitating a system upgrade. N2N is currently among 4 bidders tendering for the work to replace BOS for brokers. There are currently 28 brokers in Malaysia, and a traditional BOS typically costs RM8-12mil.

• We continue to like N2N due to: 1) its leading position in the online trading solutions space; 2) the acquisition of AFE, which offers tremendous earnings accretion; and 3) the affordability of TCPro Global, which could help the group win the market share from global competitors such as Bloomberg and Thomson Reuters.

Source: AmInvest Research - 22 Nov 2018