Investment Highlights

• We maintain our BUY recommendation on N2N Connect (N2N) with an unchanged forecasts and fair value of RM1.50/share, pegged to an FY19F PE of 25x.

• N2N’s 1HFY18 core net profit of RM7.2mil (-16.7% YoY) came in below expectation, accounting for 36% of our full-year forecast and 29% of full-year consensus estimates.

• 2QFY18 core profit came in at RM2.8mil, representing a decline of -47% YoY and -37% QoQ. The precipitous drop was largely attributable to the additional tax and penalty amounting to RM5.3mil that was fully recognised in the reported quarter. This was due to the Inland Revenue Board of Malaysia (IRB) disallowing certain capital allowances and intercompany expenses.

• As a result, we estimate an increase in effective tax rate to 26% from 6% for FY18F. However, we believe the expense is one-off in nature and therefore would not affect core earnings going forward.

• 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 industrywide 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 shortselling, 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 reiterate our view that a Main Market transfer is in the cards given that N2N’s profit track record adequately satisfies Bursa Malaysia's “profit test” requirement. The time frame for the exercise is estimated at about 6 months.

• 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 - 29 Aug 2018