Posted: 28 August 2020
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In case you have not heard the latest talk in town, this is it — Nanofilm Technologies International Limited’s (“Nanofilm”) initial public offering (IPO). As this is the last day to subscribe to this IPO, here are my initial thoughts on this IPO and this company. I am not an engineer by trade but I did my research to understand what the company does and to validate the claims it made in its prospectus.
Nanofilm was established in 1999 and engages in nanotechnology solutions (mainly coating of surfaces). It operates through 3 business units (“BUs”).
Nanofilm was established in 1999 and engages in nanotechnology solutions (mainly coating of surfaces). It operates through 3 business units (“BUs”):
- Advanced Materials BU:
- Coats customer’s products/components with its proprietary materials or metal (copper/aluminum) using techniques like Filtered Cathodic Vacuum Arc (FCVA) and FCVA-hybrid with physical vapor deposition (PVD).
- Industrial Equipment BU:
- Manufactures and sells turnkey (ready-to-use) equipment systems including coating equipment and auxiliary equipment (e.g. automated cleaning system, materials handling and assembly automation system, pre-treatment equipment
- Provides customized software, training, spare-parts, customer services and after-sales support
- Engages in R&D and development with customers to produce bespoke coating equipment that seamlessly integrate into its customers’ manufacturing lines
- Manufactures and supplies nanoproducts which are used to ensure smooth functioning of, and improvement in performance to, Nanofilm’s customers’ products
In short, the company earns revenue in the following way:
- Coating of its proprietary advanced materials on its customers’ products/components;
- Sale of coating equipment (vacuum coating chambers), automation systems and customized software;
- Maintenance / after-sales service of above equipment and systems; and
- Manufacturing nanoscale products for its customers
Purpose of Coating Products / Components
How it works?
Effectively, this technology is able coat any surface with a thin layer of material (could be a metal like Copper or Aluminum, or Nanofilm’s proprietary materials like TAC-ON (diamond-like material), iTAC or MiCC).
Understanding the "Materials Deposition" Market
I always believe that for one to invest into a company, you should try to understand what the company actually does. For me, this means understanding how the Materials Deposition market is segmented and understanding the various techniques of coating that exists in the market in order to evaluation FVAC’s superiority (as claimed in the prospectus). I have drawn up a diagram below to illustrate the market segmentation by materials deposition technique (based on this ScienceDirect document).
In essence, the market is split into Physical Vapor Deposition (PVD) and Chemical Vapor Deposition (CVD). The difference lies in how each technique vaporizes the material to be used for coating. PVD physically vaporizes the material (e.g. in the case of FVAC using a plasma, OR using heat) while CVD chemically vaporizes it. Nanofilm did a comparison of its FVAC with the traditional coating techniques.
Comparison of Coating Techniques
FVAC falls into the Cathodic Arc Deposition category. FVAC utilises a filter in a vacuum chamber to filter out impurities so that the eventual coating will be purer (i.e. higher composition of the intended material since the vaporized material will hardly ever be 100% pure).
Point proven: FVAC indeed seems to be considered a superior technology in the Materials Deposition Market.
What I like about this Company
Potentially exciting growth story
While I cannot verify the comparative superiority of Nanofilm’s technology and materials with its peers due to a lack of understanding of the industry landscape and the underlying technology, Nanofilm has been experiencing strong growth over the past three (reported) years. The key drivers of its future growth may include:
- product miniaturization trends, which will benefit its Nanofabrication BU (started in 2018);
- Increase accessibility to consumer tech, and increase adoption of video analytics / IoT applications given that majority of its Nanofabrication BU’s products are optical lenses and sensors (based on my experience, telcos are trying to build 5G B2B ecosystems that involve a lot of video analytics use cases);
- R&D and co-development efforts with customers can lead to sticky relationships;
Seemingly superior material/technology (superior margins at least…)
Given the lack of familiarity, I can only take comfort in finding comparable companies and see how it stacks up to the competitions. And what I found was that at ~40% EBITDA margin, Nanofilm pulls ahead of its peers.
Highly synergistic BUs
Revenue synergies are created between its Advanced Materials BU and Nanofabrication BU when the products designed and manufactured by Nanofabrication are coated in Nanofilm’s advanced materials. Nanofilms states that additional synergies are derived from the use of Industrial Equipment BU’s equipment in Nanofabrication BU and Advanced Materials BU — though this to mean sounds like a left pocket out, right pocket in kind of situation. Perhaps the synergy relating to its Industrial Equipment BU will come from the sale of equipment to external parties, who in turn purchases advanced materials (though this is purely speculation; there is no mention of them selling these proprietary materials on the market).
Strong Cornerstone Investor base and Over-allotment option for price stabilization
Essentially, cornerstone investors are well-established investors (like large asset manager / banks) that buy into the IPO to offer credibility to the deal. For this IPO, Nanofilm managed to secure 13 cornerstone investors including names like JPMorgan Asset Management, Aberdeen, AIA, Credit Suisse, Nikko AM, Fullerton Fund, Lion Global, Avanda Investment.
Fullerton is a Temasek-owned entity, and knowing Temasek to be the “generational investor” and the entity that champions Singapore companies (e.g. through Heliconia Capital), it is likely that Fullerton will be treating this as a long-term investment. On the other hand, Avanda is run by ex-GIC CIO and it also happens to have received S$3 billion from Temasek (though it is more of a hedge fund-like vehicle).
While this seems a rosy picture, the bummer is that only Lion Global is subject to a lock-up period. Essentially, all other cornerstone investors can start selling their shares once the company starts trading on 30 October 2020. Thankfully, the IPO is structured such that there is an over-allotment / greenshoe option to provide price stabilization.
What I dislike about this IPO/Company
High customer concentration risk and customer has significant leverage to terminate their contract
Nanofilm’s largest customer accounted for ~50% of its revenue across 2017, 2018 and 2019, and accounted for 56.5% in 1H20. Its top five customers (direct customers and end customers — e.g. direct customer may be an iPhone case manufacturer, end customer = Apple) accounted for 83%, 68% and 73% of total revenue respectively from 2017 to 2019. They accounted for 82% of Nanofilm’s revenue in 1H20.
To make matters worse, Nanofilm revealed that its agreements with the end customers grant them significant leverage over Nanofilm in terms of the right of termination, payment methods, quality standard and requirements. Some outrageous terms include “the right to cancel all or part of any purchase order at any time”, “to reschedule delivery dates or redirect shipments multiple times, without charge”. Such terms being include in key contracts really calls into question the management’s business-savviness.
Under-utilized Nanofabrication BU and Declining revenue per equipment from Advanced Materials BU
Looking at the operating metrics of the two BUs brings to surface two issues:
- Falling average revenue per coating chamber — the saving grace here is that we can observe that volume has actually increased from 2018 to 2020 (increased equipment + increased utilization); and
- Extremely low utilization of the Nanofabrication BU’s injection molding equipment
Business model leaves much to be desired
a. Industrial Equipment BU is not fully optimized for external sales
As I alluded to earlier, the bulk of “sales” from its Industrial Equipment BU comprises internal sale to the Advanced Materials BU. Although this does not show in the income statement (as intra-company sales are eliminated), the potential to cross-sell its proprietary materials from its Advanced Materials BU and the potential revenue to be made from maintenance and after-sales support services are lost.
b. High leverage makes equity investment risky
The high customer concentration and ease of contract termination, coupled with a 36% gearing ratio (net debt / total capital), really makes equity investment extremely risky (debt holders have first claim in the event of liquidation). As at 30 Sep 2020, Nanofilm has drawndown S$93.4 million, of which S$50 million owing to GLCs (government-linked corporations) are convertible notes. At least S$20 million worth of principal repayment will fall due in 2021 (c.50% of cash balance as at June 2020). Seeing that capex in 2019 and 1H20 stand at S$45.3m and S$36.2m respectively, Nanofilm will likely face a cash shortage in 2020/21. This is perhaps why capex will account for the largest proportion of the use of IPO proceeds.
IPO looks to be an opportunity for exit rather than for fundraising
The IPO is structured such that the management will sell their shares to (i) investors in the International Offering, (ii) Singapore investors in the Singapore Public Offer, (iii) Cornerstone investors as part of the cornerstone investors’ subscription (Vendor Cornerstone Shares) and (iv) the banks which are granted a 20% over-allotment option. New shares will only be issued by the company for the remaining shares sold to Cornerstone Investors (Cornerstone Shares)..
Essentially, regardless of whether the over-allotment option is exercised, the management who are selling their shares collectively receive more money than the amount received by the company (the company only receives money on the new shares issued).
IPO Structure including fully exercised over-allotment option:
IPO Structure assuming over-allotment option is not exercised:
While the issues flagged out above are significant, I am certain that my analysis is not comprehensive and I am bound to have blind spots given the lack of familiarity with the information presented and the industry as a whole. The fact that it attracted so much institutional attention is a statement in itself.
For those who are adventurous / stronghearted enough, this IPO may be worth considering as the potential upside will be immense if it manages to break into the new markets (like fuel cell, renewables, etc.) as mentioned in the Prospectus. Please proceed with caution and only put in money that you can afford to lose and earn back. Looking at the implied valuation multiple and comparing them to peers suggests that the company maybe overvalued (keep in mind that Tokyo Electron is 10x the size of Nanofilm with lower margins).
Nanofilm’s implied multiples:
- P/E: 42.1x
- P/B: 12.1x
- EV/EBIT: 34.6x
- EV/EBITDA: 25.5x
- EV/Revenue: 10.9x
Personally, I would avoid this IPO as it seems to be structured for existing stakeholders to exit — for management to cash out on their shares and for debt holders to make sure that they get paid when principals fall due. The book building process saw a 19x over-subscription so perhaps institutional investors see something more to this than retail investors given their massive resources. So decide for yourself if this risk is worth taking!
(Edit: Do note that it is commonplace for cornerstone investors to have no lock-up period in the Singapore IPO market.)