Salutica is slated for listing on the Ace Market of Bursa Malaysia on 18 May. The exercise involves the issuance of 78m new shares and offer for sale of 23m shares at an IPO price of MYR0.80 /share. We value the firm at MYR1.18 (48% upside) based on our target 2017 P/E of 10x, ie in line with its peers . We are forecasting for an earnings CAGR of >40% for FY15-18, which translates into an appealing PEG of 0.24x.

Riding on Bluetooth growth. Bluetooth has become one of the most prevalent and pervasive wireless technologies available today. This is evident in the fast growing Bluetooth- enabled devices shipments, which jumped to 3bn units in 2014 from 1.8bn units in 2011 – a CAGR of 18.6%. Independent market researcher Smith Zander International expects global shipment volumes to hit 4.9bn units by 2018. The adoption of Bluetooth technology to enhance connectivity wll play a significant role in the Internet of Things (IoT)environment. We believe this could ultimately spur demand for Bluetooth related devices , which, in our view , could benefit Salutica in the long run.

New models to drive growth. In 2011 -2013, Salutica secured manufacturing contracts for the design and production of Bluetooth stereo handsets from Plantronics Inc and Jaybird LLC. Currently, Salutica has three existing surface mount technology (SMT) lines with maximum output of approximately 14m units pa. Post IPO, it is looking to procure a new line to in crease SMT capacity by >32% to 18.5m pa. We believe the capacity expansion is intended to eye more outsourcing opportunities from Plantronics and Jaybird. Based on our findings, Jaybird is set to launch two new products called Freedom and X3 in 2Q16 ,while Plantronics is looking to launch 1-2 new models over the next 6-12 months. Ultimately, these new launches by its customers could spell more job opportunities for Salutica over the near to medium term.

Looking to bag a new product. On top of that, Salutica is currently in the midst of securing a contract to manufacture a USB-powered device that adds touchscreen functionality to non -touch laptop screens. Approximately MYR10m of the IPO proceeds are be utilis ed to purchase a new production line with an annual installed capacity of 3m devices dedicated for this new product. We expect the installation to take place in 4Q16 , with mass production to commence by early-2017. Earnings accretion is likely to be felt come 2HFY17(Jun).

Our valuation estimate of MYR1.18 is pegged to a target 2017 P/E of 10x, which is in line with local peers VS Industry (VSI MK, BUY, TP : MYR1.68) and SKP Resources (SKP MK, NEUTRAL, TP: MYR1.42). This is further supported by a corroborative DCF valuation of MYR1.28 that implie s a 2017 P/E of 10.8x, ie close to our target P/E. Management is committed to a dividend policy of no less than 30% going forward. This offers decent dividend yields of 2.3 -5.3% for FY16F-18F.

Key risks include customers’ concentration risk ( its three largest customers contributed close to 90% of its FY15 revenue), dependence on foreign labour(75% of its workforce), and susceptibility to forex fluctuations , given that its sales are predominantly in USD.

IPO Structure The IPO is set to raise MYR62.4m Salutica is slated for listing on the Ace Market of Bursa Malaysia on 18 May. The exerciseinvolve s the issuance of 78m new shares and offer for sale of 23m shares at an IPO price of MYR0.80 per share. The exercise would raise MYR62.4m in gross proceeds. Post IPO, the equity interests of the single - largest shareholder, ie the Lim family , would stand at 67.7%. This is via the family ’s vehicles Blue Ocean Enlightenment SB and Genius Thinkers SB.

Business Overview Company background Salutica is an investment holding company. Its 100% -owned subsidiary Salutica Allied SBis the main business entity. Salutica Allied commenced operations in 1990 as an original equipment manufacturer (OEM), principally involved in the manufacturing of precision plastic pars and components for the electronics industry. Over the years, the company has transformed. It is now involved in the design, development and manufacture of consumer electronic products , with the focus primarily on Bluetooth -related devices. Salutica Allied’s niche is essentially in being a one- stop solutions provider for external brands . This is given its fully vertically -integrated operations. At the same time, the company is engaged in the development of its in - house tyre pressure monitoring system (TPMS) products under the FOBO brand. Currently, Salutica’s manufacturing base is in Ipoh, Perak, and sits on three pieces of contiguous land measuring 9.6 acres in total. Its production plant has a total manufacturing floor space of approximately 30 ,000 sq ft.

Management team led by largest shareholder Mr James Lim is the group’s MD/CEO. An electrical and electronics engineer by profession, his previous stints include ASEA AB of Sweden, Maxtor Corp, Applied Magnetics SB and Seagate Technology. He joined Salutica Allied in 2004 as CEO and helped set up the research & development (R&D) division to focus on Bluetooth technology. In 2013, Mr Lim led a managemen buyout of the company from the Balda AG Group when the latter stated its inten t to focus on its core business , medical precision plastic parts and solutions.

Investment Highlights Riding on the growth in Bluetooth devices Bluetooth has become one of the most prevalent and pervasive wireless technologies available today. Its role has evolved with the advancement of technology and the expansion in the consumer electronics product lines to accommodate new functions . These include connected home and wearable technology. This is evident in the fastgrowing Bluetooth- enabled device shipments , which jumped to 3bn units in 2014 from 1.8bn units in 2011 – a CAGR of 18.6%. Independent market researcher Smith Zander International expects gobal shipment volumes to hit 4.9bn units by 2018, as the adoption of Bluetooth technology to enhance connectivity is to play a significant role in the IoTenvironment. We believe this could ultimately spur demand for Bluetooth -related devices ,which – in our view – could benefit Salutica in the long run. It is currently a member of the Bluetooth Special Interest Group, which owns the Bluetooth trademark, oversees development of Bluetooth standards, publishes technological specifications and administers its qualification programme.

On a side note, we highlight that the next-generation flagship smartphones could get rid of headphone jacks altogether. Notably, Apple Inc is widely anticipated to launch its iPhone 7series this coming September. The market is rife with talk that Apple is eliminating the headphone jack to reduce the thickness of its next-generation smartphone line- up. This, if it materialis es , could spark demand for Bluetooth-enabled audio devices . A t the same time, this ought to compel existing Bluetooth headphone brands such as Plantronics and Jaybird to up the ante for better audio output quality to entice buying interest. Should other handset makers decide to follow Apple’s move in getting rid of the standard 3.5mm headphone jack, we see plenty upside potential for Salutica to tap into this opportunity by leveraging on its niche within the Bluetooth space.

New models to be launched by its customers In 2011 -2013, Salutica secured manufacturing contracts for the design and production of Bluetooth stereo handsets from Plantronics and Jaybird. Currently, the group has three existing SMT lines with a maximum output of approximately 14m units pa. Post IPO, it is looking to procure a new line to increase its SMT capacity by over 32% to 18.5m pa. We opine that the capacity expansion is intended to eye for more outsourcing opportunities from Plantronics and Jaybird. Based on our findings , Jaybird is set to launch two new products named Freedom and X3 in 2Q16. Following the unveiling of the new series at the Consumer Electronics Show 2016 in January, early reviews – on better battery performances – have thus far been positive. The new models use the more power- efficient Bluetooth 4.0 wireless technology. On the other hand, our channel checks indicate that Plantronics is looking to launch 1- 2 new models over the next 6-12 months. Ultimately, these new launches by its customers could spell more job opportunities for Salutica over the near to medium term.

Looking to bag a new product Beyond its existing focus on Bluetooth audio devices, management is currently in the advanced stages of securing a contract to manufacture a USB - powered device that addstouchscreen functionality to non -touch laptop screens. This unnamed device uses infrared and proprietary software to detect a user’s touch position on the display monitor of a laptop . Salutica has been in active discussions with this potential customer for the past six months. It also participated in both the design of the prototype as well as dis cussions on the manufacturing process flow for commercial production to take place . Management said approximately MYR10m of the IPO proceeds are be utilis ed to purchase a new production line – with an installed capacity of 3m devices pa – dedicated to this new product. We understand that, as opposed to its typical SMT lines, this new line is an automated wafer chip and electronic component s encapsulation production system . It also has the additional capability to mount wafer chips and perform wire bonding. We expect the installation to take place in 4QFY 16, with mass production to commence byearly -2017. Earnings accretion is likely to be felt come 2HFY17.TPMS to gradually take off

To reduce the group’s dependence on third party manufacturing contracts, management spent over MYR5m in 2012 -2013 to develop its own TPMS products under the FOBObrand. In essence, the TPMS system allows users to monitor real -time vehicle tyre pressure using Bluetooth 4.0 technology. Currently, FOBO’s offerings cover a broad range of platforms , which includ e bikes, cars, light trucks and vans. Management is looking to officially launch its FOBO Ultra product, to cater for heavy -duty trucks , by June.

On the other hand, Salutica is looking to penetrate into more e -commerce platforms to increase awareness of its brand. Currently, sales are conducted t hrough its own ecommerce site (http://www.my-fobo.com) as well as third party platforms such as Amazon, Lazada and Mudah.com. In addition, m anagement has appointed local and overseas distributors to penetrate into physical retail outlets. In Malaysia, FOBO products are available in 47 retail point of sales in Malaysia through authorised distributor Sunweu SB, which is involved in the distribution of mobile phone accessories in Malaysia. On the overseas front, Salutica has selected 29 distributors to help ma rket its products. FOBO sales made up approximately 1% of Salutica’s FY15 revenue at MYR3.5m . We expect this to increase to MYR8m-10m by FY17-18. This is as we see potential for this aftermarket solution to gain momentum , given that there is a large numbe r of vehicles on the road that do not come pre-installed with this specification.

Working on new in-house products To capitalise on the strength of its R&D division – which accommodates over 30 personnel – to drive product development and new innovations , management is exploring potential opportunities within the healthcare industry. We gather that this would likely be in the form of the development of electronic devices for personal health moni toring , eg blood pressure and glucose monitors for home usage. This could be management’s long-term strategy to grow its own products portfolio to reduce dependence on third- party manufacturing contracts. Salutica said that commercial rollout could take place by 2019 or 2020.

Risk Factors Customer concentration Salutica’s three largest customers contributed close to 90% of its sales in FY14 and FY15. The potential loss of these customers could have significant negative impact on the group’s financial performance. Nonetheless, we believe such an outcome is unlikely, as Salutica has established business relationships of 4 -10 years with each of them. The group is also on the approved suppliers’ list for the three firms.

Sales and raw material procurement in USD Over 95% of Salutica’s revenue is derived in USD. This , however, is partly mitigated by its raw materials procurement, which is denominated in the same currency. We estimate that every 1% strengthening in the MYR against the USD could potentially impact Salutica’s bottomline by 1-2%, assuming all else as constant.

Sales and raw material procurement in USD Over 95% of Salutica’s revenue is derived in USD. This , however, is partly mitigated by its raw materials procurement, which is denominated in the same currency. We estimate that every 1% strengthening in the MYR against the USD could potentially impact Salutica’s bottomline by 1-2%, assuming all else as constant.

Source: RHB Research - 5 May 2016