We  initiate  coverage  on  Inari  Amertron  with  a  BUY  and  fully-diluted MYR3.49  FV,  pegged to  a  16x CY15F  P/E  (assuming full conversion of its outstanding warrants of  140.0m). We expect  it  to register FY14-16F earnings of MYR89m-152m, implying a  sturdy  31%  CAGR. We like  this stock  for  its: i)  established  partnership with  Avago, ii)  exciting growth prospects  from  newly  set  up  divisions,  and  iii)  decent  balance  sheet backed by strong operating cash flow.

• Background. Inari Amertron  is involved in the electronics manufacturing systems  industry.  The  group  provides  semiconductor  components packaging and testing services  as well as  manufacturing  optoelectronic equipment. On  top of that,  it  recently diversified into  the  electronics test and  measurement  (ETM)  segment  as  well  as  fibre  optics  componentsmanufacturing. Currently,  Inari Amertron  operates from  nine  production plants located in Malaysia, the Philippines and China.
• Established  partnership  with  Avago  Technologies  (Avago)  (AVGO US, NR).  Avago is Inari Amertron’s single-largest customer,  contributing >70% of its current  total sales. These mainly comprise key  services  like package  assembly  and  testing.  Of  note,  Avago’s  radio  frequency integrated circuits (RFICs) are among the most reliable in the world and Inari  Amertron  is  poised  to  benefit  from  this  by  virtue  of  being  one  of Avago’s  three  main  RFIC  assembling  and  testing  contractors.Meanwhile,  under  its  optoelectronics  arm,  the  group  manufactures products  like light-emitting  diodes (LEDs) and  infra-red (IR) sensors for Avago.
• New  growth  drivers.  To  diversify  its  earnings  base,  Inari  Amertron recently ventured into the ETM business via its 51%-owned Ceedtec SB. Notably,  the  latter  is  being  incubated  to  become  an  original  design manufacturer  (ODM)  for  Agilent  Technologies  (A  US,  NR).  The  group has also moved into research, design and manufacturing of fibre opticsrelated products  through  its 100%-owned Inari South Keytech SB  (ISK). The  latter  commenced  production  of  a  new  fibre  optics  component  for Avago  in  January.  We  estimate  that  these  two  new  divisions  should contribute 15-20% of Inari Amertron’s total revenue by FY16.

Corporate background. Inari Amertron was founded in 2006 by Ho Phon Guan, Mai Mang  Lee  and  Tan  Lee  Pang,  as  Inari.  The  group  started  out  as  a  chip  module assembler  and  naturally  progressed  into  a  one-stop  semiconductor  packaging  and testing  services  provider.  In  2011,  it  was  listed  on  the  ACE  Market  with  an  initial market  capitalisation  of  MYR126.0m.  Since  then,  Inari  Amertron’s  market  cap  has grown  more  than  10-fold  to  MYR1,415.2m.  On  3  June,  the  group  completed  its transfer to the Main Market.

Shareholding structure.  Insas (INS MK, NR) holds  a  33.1% in  Inari  Amertron,  with Macronion  SB  and  group  co-founder  Ho  holding  6.8%  and  5.7%  respectively.  The group  completed  its  acquisition  of  Philippines-based  optoelectronics  manufacturer Amertron  Global  in  2013  for  MYR101.7m,  which  resulted  in  it  adopting  its  current name.  Inari  Amertron  has  a  workforce  of  approximately  5,000  across  nine manufacturing  plants  in  Malaysia,  China  and  the  Philippines.  Management  is currently led by a team of experienced engineers and industry experts ,  with Dr Tan Seng Chuan at the helm as executive vice  chairman and  Lau Kean Cheong as CEO and executive director.

Existing operations.  Today, Inari  Amertron  has four main business concentrations namely: 
i)  integrated packaging and testing services 
ii)  optoelectronics manufacturing, testing and assembly 
iii)  ETM equipment ODM 
iv)  fibre optics design and manufacturing

Packaging  services.  Under  its  integrated  packaging  and  testing  services  (IPTS) division,  which  makes  up  40-50%  of  its  FY13  revenue,  Inari  Amertron  provides services such as backend wafer processing, package assembly and final testing of semiconductor components. Avago is  the group’s  single-largest customer under this segment,  contributing over >90% of its segmental sales. Avago’s RFICs  are among the  most  reliable  in  the  world,  and Inari  Amertron  is  poised  to  benefit  from this  by virtue  of  being  one  of  the  three  main  RFIC  assembling  and  testing  contractors. Through Avago, Inari  Amertron  would  then  be able to tap into the smartphone and tablet market, which  is  forecasted to grow at  a  CAGR of  12-17%  over the next  four years. Note  that the former’s  RFICs  are currently found in flagship  smartphones and tablets such as  Apple (AAPL US, NR)’s  iPhone 5s  and  iPad Air,  Samsung (005930 KS, NR)’s  Galaxy S5  and  HTC (2498 TT, NR)’s  One  (M8)  and  Xiaomi  Inc’s  Mi-2s. With the upcoming iPhone 6 rumoured to be launched by September, we expect Inari Amertron to receive pent-up demand on orders for its RFICs over the near term. This,in  our  view,  could  help  to  further  bump  up  its  existing  85%  utilisation  rate  with  an 
installed  capacity  of  1.4bn  units  currently.  Going  forward,  we  see  this  segment growing  at  13-25%  annually,  driven  by  demand  from  the  smartphone  and  tablet markets for RFICs. 

Optoelectronics  arm.  Under its optoelectronics arm, Inari  Amertron  –  via its 100%-owned  Amertron  Global  subsidiary  –  manufactures,  tests,  and  assembles optoelectronics  products  like  LEDs,  LED  displays,  IR  sensors  and  opto-couplers. These products are mainly for use in data centres as well as the aerospace, defence, industrial  automation  and automotive  industries.  The  optoelectronics  segment as a whole  makes  up  50-60%  of  Inari  Amertron’s  FY13  consolidated  sales,  with  net margins  typically  stable  at  4-6%.  Amertron  Global  currently  operates  from  three plants, ie  one in Jiangsu, China, and the  other two in Clark Field and Paranaque  in the  Philippines.  Currently  its  major  customers  under  this  segment  are  Avago  and Osram  (OSR  GR,  NR),  making  up  estimated  segmental  sales  of  70%  and  20% respectively.  Given  that  demand  for  Inari  Amertron’s  existing  products  under  this segment is  relatively stable, we are forecasting  for  growth of  mid to high single digits
per annum going forward.

ETM  ODM.  To further diversify its earnings base, Inari  Amertron  has ventured into the  ETM business via 51%-owned  Ceedtec. Notably, the latter  is being incubated to become an ODM  for Agilent, a  leader in the design, development and manufacturing of  electronic  test  and  measurement  products.  Ceedtec  currently  operates  from  its manufacturing and test facility on  Penang  Island,  taking into account the proximity  to Agilent’s  office  in  Bayan  Lepas.  Although  contribution is  relatively  negligible  at  this juncture,  we  expect  numbers  to  pick  up  substantially  over  the  next  two  years, potentially  contributing  5-13%  of  the  bottomline.  In  addition,  we  believe  Inari Amertron  could  potentially  benefit  from  the  Malaysian  Government’s  Economic Transformation Programme (ETP), which is designed  to  transform  the  country  into a high-income nation by 2020. Agilent was selected to champion one of the Entry Point Projects  (EPPs)  under the  “building a test and measurement hub”  category. Ceedtec was selected as one of Agilent’s  local small and medium enterprise (SME)  vendors. Management  guided  that  over  15  new  products  are  currently  in  the  final developmental stage, with introduction in stages to Agilent from April. Some of these include  automated  test  equipment  for  automotive  applications,  ie  automotive functional  test  systems  for  anti-lock  brakes  (ABS)  and  engine  control  unit  (ECU) testing.  Others  include  precision  bench-top  power  supply  for  laboratories  and manufacturing testing

Fibre  optics.  On top of that, Inari  Amertron  has also moved into research, design and  manufacturing  of  fibre  optic-related  products  via  100%-owned  ISK.  The  group commenced production of new fibre optic products  for Avago in January. Although revenue contribution is marginal  at this juncture,  as this is only  the  product pipeline’s initial phase, we  are  positive on management’s move to build its core competency in the increasingly prevalent  and high demand  fibre  optics technology  segment. Some of the new products that the group is working on include fibre  optics transmitters and receivers for usage  in  the  telecommunications industry,  eg data centres  and  server switches.  Going forward,  we estimate  that  the revenue from this division to grow at 30-60% from FY15, which should translate into earnings contributions of 7-10%.

R&D  initiatives.  As  Inari  Amertron  operates  in  a  highly  technical  and  fast-moving industry,  the group  places a heavy emphasis on  R&D  to  ensure  that it  stays  on the cutting  edge  of  technology.  As  end-products  become  smaller  and  lighter,  Inari Amertron  is  developing  its  capabilities  in  miniaturisation  processes  and  assembly. The group is now focusing on developing a packaging process for copper pillar bump technology,  which  should  substantially  reduce  the  PCB  footprint  of  a  chip  down  to 75μm. As a comparison, the gold standard in SMT is 150μm x 200μm. Inari Amertron has also been granted several grants  totalling MYR27.2m  by MIDA and the  Northern Corridor  Implementation  Authority  (NCIA)  for  packaging,  fibre  optics  and  ODM technology  R&D.  We  believe  that  the  group’s  research  is  heading  in  the  right direction and this should translate into future earnings.

Industry  outlook.  International  Data  Corporation  (IDC)  expects  worldwide smartphone shipments to reach 1.2bn units in 2014, an increase of 23.1% from 2013. IDC also  expects total smartphone volume  to reach 1.8bn in 2018, with a CAGR of 12.3%  in  2013-2018.  The  growth  will  be  driven  by  demand  from  key  emerging markets like India, Indonesia and Russia. By 2018, IDC expects China to account for one-third  of  all  smartphone  shipments  worldwide.  As  I nari  Amertron  supplies  to Avago,  which,  in  turn,  supplies  to  major  smartphones  producers  like  Apple  and Samsung,  we  believe  Inari  Amertron’s IPTS  segment  should  be  riding  high  on  the wave  of  the  smartphone  boom.  Although  still  in  its  infancy,  we  believe  that  the group’s  strategy  of  diversifying  into  the  fibre  optics  equipment  space  was  the  right choice.  Cisco (CSCO US, NR)  estimates  that annual global data  centre  traffic  couldreach 7.7 zettabytes  (ZB)  by end-2017  vs just  2.5ZB  in 2012.  This traffic  growth will be driven by demand for cloud computing and the  “Internet of Things”  (IOT), ie how all  data  will  be  connected  through  the  Internet.  Data  telecommunications  research firm  LightCounting  predicts that the  global fibre optics equipment  market is expected 
to  grow to USD5.1bn in 2017  from  USD3.4bn in 2012,  as cloud computing matures and IOT takes shape. Inari Amertron supplies to Avago, which counts Cisco and IBM(IBM US, NR)  as its major fibre optics equipment  customers.  Coupled with the ban imposed by the US  Government on  Chinese firms ZTE (763 HK, NR)’s  and Huawei Co Ltd’s  telecom  equipment, we foresee  that  Inari  Amertron’s  fibre optics equipment could be in demand. The need for faster and higher bandwidth in telecommunications network will  require a  change to  a fibre optic network. A  traditional  copper backbone network will not be able to cope as it has much lower speed and smaller bandwidth.

Source: RHB