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Sunday, June 9, 2019

(CHOIVO CAPITAL) A Look At OPENSYS (M) Berhad (OPENSYS)

Author: Choivo Capital | Publish date: Sun, 9 Jun 2019, 2:47 AM

For a copy with better formatting, go here, its alot easier on the eyes.

A Look At Opensys

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Well, its been sometime since I last wrote. And well, it was mostly out of me being a little lazy, more focused on my reading, as well as some self-reflection in terms of my investing and how I go through life in general.

In any event, I decided to get back in the groove of things with this bit of research I did for OPENSYS (M) Berhad.

The reason i’m sharing this is due to,
Better or similar opportunities in the market, especially globally, given the fall in prices recently.

I’ve already bought my position. For the record, it’s a smallish position mainly due to me finding opportunities elsewhere.

In addition, I also felt that as most of my insight was already stated out in bits and pieces by others via blogpost or comments, with some stretching back to 2015. It would not make much difference for me to share my research.

As always, criticism is preferred.

OPENSYS (M) Berhad (KLSE: OPENSYS - 0040)
Recommendation

We are long OPENSYS (M) Berhad (OPENSYS – 0040), with intrinsic value estimated to range from RM0.273 to RM0.664 per share. This represents a range from, a downside of 11% to an upside of 118% from the current share price of RM0.305.

Business Description

OPENSYS (M) Berhad principal activity consist of assembling and maintaining machines/providing solutions relating to,

CRM Machines (2012 onwards)
Cheque Truncation System (CTS)
Payment Kiosk

Prior to 2012, the company’s main business consists of providing cheque processing services by selling and maintaining the CTS machines, which via image processing, converts cheques and standing instructions into electronic fund transfer instruments, with as much as 80% operational cost savings to banks at less than half the price of traditional systems, as there was no need for the physical movement of cheques.

They also provided non-cash-dispensing self-service kiosks that allowed customers to make deposits of cheques and cash, pay bills and renew insurance premium and subscription plans using cash, cheques, credit and debit cards.

In both areas, they are both the cost, product and market leaders. However, both industries are currently in a period of contraction.

Cheques used to be the only/easiest way to provide multiple approvals for certain payments, however, these days, most banks have made special approval tokens, that can be given to multiple individuals and only have payment made when all relevant parties have given approval via those tokens.

As for Payment Kiosk, most of these with online and electronic payments, not much point going to a branch to use a computer, when you can do so at home.

The company makes money by selling the machines at a gross profit margin of 10 - 15% and charges an annual maintenance fee of 10 – 12% for the machines. The main portion of the profit comes from the maintenance services which have much higher margins.

In 2012, they embarked on a new area of growth via CRM Machines, an industry which many would also consider a declining industry, but I digress.

Investment Thesis

Cash Recycling Machines are the best product/solution based on first principles.

Compared to other solutions, such as Cash Dispensing Machines and Cash Deposit Machines, Cash Recycling Machines offer roughly 30% savings in operational cost and capital expenditure.

The logic is quite straightforward, you now only need one machine, and as the machine can both accept and dispense cash, the amount of times you will need someone to come and either collect/refill the money will naturally reduce by around half.

Cash will continue to consist of the bulk of payments (by transaction count) globally for a long time.

Other than Sweden, cash is still widely utilized worldwide making up 85% of global transactions by volume.

Now, naturally most will point to China, where cash is used increasingly less due to the proliferation of QR codes.

The question we need to ask is, are situations like these the rule or the exception?

Despite the systems used by Alipay etc being the best technologically (highest capacity and processing speed) and having the lowest cost. Why is VISA and Mastercard still the mainstay globally?

Why do people still use credit cards and debit cards instead of e-wallets like Alipay etc? The reason is two pronged.

Firstly, the Chinese population was severely under-banked back when Taobao etc was launched by Alibaba etc in 2003 and 2004. Alibaba then introduced Alipay as a solution process payments on that platform.

With the sheer growth in these online shopping platforms which very quickly captured the bulk of the market for both suppliers and customers.

This resulted in most people in China having and using an Alipay account, before they even had a bank account, much less a debit or credit card.

Other than car loans, housing loans and corporate loans, the people of china completely skipped this process of being banked by traditional providers.

This meant there was no momentum or vested interest stopping banks or financial providers from going cashless.

The second reason is, till today, Alipay does not charge even 0.01% in transaction cost for any of the more than USD6 trillion processed each year. They make money from the fact that the vast majority of the Chinese people actually keep their savings and current accounts on ALIPAY, and buy their money market funds, fixed deposit and other financial products.

This meant that most merchants are more than happy to use ALIPAY. This is clearly not the case in Malaysia or most countries.. Most e-wallets merely serve as aggregators for other payment services such as Master, Visa etc, which charge a fee from 0.15% to 2% depending on the type used.

Good luck having vendors swallow that, especially since they can’t charge more for people paying using debit/credit cards, pursuant to a new BNM ruling. And let’s not forget the monthly fee to rent a merchant processing machine, which Alipay does not charge.

I don’t see my favorite hawker ever taking payment via visa anytime soon.

Currently, most e-wallets are going on a tear bleeding money like crazy to acquire customers. Touch N Go went from making RM20m a year to losing RM40m a year just from trying to acquire customers. The only reason most people have in using the current e-wallet services (Grab, Boost etc) is due to these customer acquisition promotions.

At some point, the Softbank etc venture capital money is going to run out, and these companies are going to need making money. I bet they will run out of money before people stop using cash.

The Opensys Edge

Currently, OPENSYS is the market leader in CRM machines, with 80% of the market share.

Most people may not know this, but CL Systems was the first in 2011 to introduce a self-service cash recycler machine. OPENSYS only thought started going through the process of qualifying for providing the machines in 2012 and sold their first machine late 2012.

Despite giving their competitors a head-start, by 2016, OPENSYS still obtained an 80% market share of the CRM Market, with the remaining 20% shared by CL Systems, NCR and Diebold Nixdorf.

This out-performance can be attributed to a few reasons,
For most banks, the Cash Deposit and Cash Dispensing Machine runs on two different computer systems, the difficulty then lay in creating the software to combine these two channels into one. OPENSYS was the first to do that.

This business is similar the rubber glove business, in that the maintenance and capital expenditures machines consist of a small portion of the Bank’s cost, with service, quality and technology being the focus of the banks, assuming the pricing is similar.

In these areas, OPENSYS is easily the best, with the two most kiamsiap and China-man banks in Malaysia, Hong Leong Bank and Public Bank adopting their CRM machines en-masse.

This one is purely anecdotal, however, unlike CL Systems, NCR and Diebold Nixdorf, OPENSYS/OKI is a local business run by local Chinese.

The other 3 are MNC’s whose base of operations are in Hong Kong, America and Germany, with the Malaysia business is run by one of their local branches.

Well, I would bet my money on the local Chinese with skin in game, being a lot more driven than some Ang-Moh manager here on work holiday.

Catalyst
High probability of tripling to quintupling the profit related to Software Solution & Services

Recently, Bloomberg just reported that for the first time in a long time, the number of ATM’s have fallen by 1% globally.

What Bloomberg does not tell you, is that their ATM count consist of 4 different types of machines. They are, Cheque Deposit Machines, Cash Deposit Machines, Cash Dispensing Machines and Cash Recycling Machines.

Given the 30% savings operational maintenance and capital expenditure, banks are often replacing two machines (cash dispensing and cash depositing) with one cash recycling machines. Share of these machines have increase from 34% to 38% compared to the previous year.

They are currently roughly 17,500 (2017) Cash Dispensing and Cash Depositing machines in Malaysia, with growth expected to be roughly 5% per annum. To be conservative, let’s assume growth to be zero.

20% of them consist of CRM machines, with OPENSYS having 80% market share. They had installed a total of 2,500 and 3,200 CRM as of 2017 and 2018.

Most ATM and CDM machines were likely to have been bought before 2015, when OPENSYS is going around making banks aware of the technological and cost benefits of CRM’s, having started selling to Hong Leong and Public Bank, as well has having passed trials for other banks.

As most banks in Malaysia are now fully aware of the technological and cost benefits of CRMs and are planning to replace their machines CRMs when their equipment reaches the end of their life-span, which are typically 8 to 10 years. (Other factors such as end of vendor support for software operating systems, regulator changes and compliance to international standards, may shorten the replacement cycle for ATMs and CDMs.)

We can safely say the bulk of the remaining 80% of non-CRM, Cash Dispensing and Cash Depositing Machines in Malaysia will be replaced within the next 5 years.

Given OPENSYS’s ability to hold 80% market share within 2 years, despite giving their competitors a 1-year head start, it seems highly likely that they will be able to maintain this market share as the remaining machines are replaced.

Giving a potential 5X growth in maintenance revenue and earnings in 5 years, or 3X growth, assuming that the remaining 80% is evenly split between Cash Dispensing and Cash Depositing machines, and they are converted to CRM Machines on a 2 to 1 basis.

Ie: One Cash Dispensing and one Cash Depositing machine, is converted into one CRM Machine.

Key Risk

OPENSYS may not be able to maintain the market share.

Currently OPENSYS have sold CRM machines to every major bank in Malaysia, however, the bulk of the machines are sold to Hong Leong Bank, Maybank and Public Bank.

It is a little odd, why the rest of the banks seem to be a little slow in adopting the CRM compared to those two banks who are replacing the machines very aggressively. Especially since so many Cash Dispensing and Cash Depositing machines are so old.

It could be the typical GLC “take your time” attitude, or it could be a matter of solving the software programming to tie up both cash dispensing and cash depositing computer systems.

Forex Risk

Profits from the sale of the machines do get affected by forex risk, as purchase is denominated in JPY. However, this is not the bulk of the value of this Company in our opinion.

The Company is unable to maintain non CRM related Software Solution & Services revenue and profit

The non CRM related Software Solution & Services revenue and profit may well fall exceeding the gain in CRM related ones.

I don't think the revenue related to kiosk is significant, however, we may very well be proven wrong.

Valuation

For our valuation, extremely conservative assumptions will be taken, and four different scenarios will be performed, common assumptions are as follows.
0% Growth in Total number ATM and CRM machines (Consensus is 5% growth).
Discount Rate of 4.5%.
All un-allocated Expenses and Income relate to “Software Solution & Services” (SSS).
20% of Machines are CRM, remaining 80% is equally split between Cash Deposit and Cash Dispensing Machines. (Cash Dispensing Machine is likely to be far more than Cash Deposit Machine)
Tax Rates of 24%.
Zero profit from CRM Machines (This is the most onerous and unlikely one).
The market values OPENSYS at a PE of 10 in 5 years.




Scenario 1

Profit 5 years from now is calculated by taking the 2018 SSS Profit, less all un-allocated income and expenses. A corporate tax rate of 24% is then applied.

The remaining 80% Cash Deposit/Dispensing Machine are all converted into CRM Machines (essentially X5).

2018 SSS Profit: RM20,293,304
Less: 2018 Net Unallocated Income and Expense: RM(13,743,823)
Equals: Profit Before Tax: RM6,549,481
Less 24% Corporate Tax - Profit After Tax: RM4,977,606
Profit After Tax in 5 Years when remaining 80% Machines Converted to CRM (X5):RM24,888,028
Market Capitalization in 5 years (10PE): RM248,880,280
Discounted at 4.5% for 5 years: RM197,700,306
Price per Share: RM0.664

Scenario 2

This scenario is the same as scenario 1, except, the remaining 80% Cash Deposit / Dispensing Machine are all converted into CRM Machines on a 2 to 1 basis (essentially X3).

It assumes that if a branch has one Cash Deposit Machine and one Cash Dispensing Machine, it will be converted to one CRM Machine. This is quite unlikely as banks usually convert both to a CRM.

2018 SSS Profit: RM20,293,304
Less: 2018 Net Unallocated Income and Expense: RM(13,743,823)
Equals: Profit Before Tax: RM6,549,481
Less 24% Corporate Tax - Profit After Tax: RM4,977,606
Profit After Tax in 5 Years when remaining 80% Machines Converted to CRM on a 2:1 basis: RM14,932,817
Market Capitalization in 5 years (10PE): RM149,328,170
Discounted at 4.5% for 5 years: RM118,620,183
Price per Share: RM0.398

Scenario 3

This scenario is a much more conservative.

The profit 5 years from now, is calculated by taking the "Incremental net profit before tax growth related to CRM SSS only", that is then added to the current 2018 SSS Profit, less all un-allocated income and expenses in 2018. A corporate tax rate of 24% is then applied.

"Incremental net profit before tax growth related to CRM SSS only" is calculated by taking only the difference in SSS profit in from 2012 to 2018 (first machines sale is in late 2012, maintenance service revenue kicks in on 2013), less the proportioned (based on % of the 2012-2018 difference, on 2018 SSS Profit) un-allocated expense and income.

The remaining 80% Cash Deposit/Dispensing Machine are all converted into CRM Machines (essentially X4).

This scenario this amount assumes that the non CRM related revenue and profit is maintained.

However, it also severely understates the growth in in CRM related revenue and profit, as the gain in CRM related SSS profit is more than the net difference, due to the fall in cheque processing SSS profit from 2012 to 2018.

It sounds a bit confusing, but you can better understand it from the working below.

Difference in 2018 and 2012 SSS Profit: RM10,698,078
Less: Proportioned Un-allocated Expense And Income: RM(7,245,370)
Equals: Profit Before Tax from CRM only: RM3,452,708
Profit Before Tax from CRM only in 5 Years when remaining 80% Machines Converted to CRM: RM13,810,833 (A)

2018 SSS Profit: RM20,293,304
Less: 2018 Net Unallocated Income and Expense: RM(13,743,823)
Equals: Profit Before Tax: RM6,549,481 (B)

(A+B) Less 24% Corporate Tax - Profit After Tax: RM15,473,839
Market Capitalization in 5 years (10PE): RM154,738,390
Discounted at 4.5% for 5 years: RM122,917,841
Price per Share: RM0.413

Scenario 4

This scenario is the same as scenario 3, except, the remaining 80% Cash Deposit / Dispensing Machine are all converted into CRM Machines on a 2 to 1 basis (essentially X2).

It assumes that if a branch has one Cash Deposit Machine and one Cash Dispensing Machine, it will be converted to one CRM Machine. This is quite unlikely as banks usually convert both to a CRM.

Difference in 2018 and 2012 SSS Profit: RM10,698,078
Less: Proportioned Un-allocated Expense And Income: RM(7,245,370)
Equals: Profit Before Tax from CRM only: RM3,452,708
Profit Before Tax from CRM only in 5 Years when remaining 80% Machines Converted to CRM: RM6,905,417 (A)

2018 SSS Profit: RM20,293,304
Less: 2018 Net Unallocated Income and Expense: RM(13,743,823)
Equals: Profit Before Tax: RM6,549,481 (B)

(A+B) Less 24% Corporate Tax - Profit After Tax: RM10,225,722
Market Capitalization in 5 years (10PE): RM102,257,220
Discounted at 4.5% for 5 years: RM81,228,951
Price per Share: RM0.273

Conclusions

Needless to say, if one were to properly take into account in the valuations,
The consensus 5% growth in total number ATM and CRM machines.

The profit from CRM Machines over five years fully paid out as dividend amounting to RM115,200,000:
Selling price: RM72,000 per machine
12.5% margin
12,800 machines - remaining 80% not yet converted to CRM, assuming same market share.

Valuations are likely double at minimum. However, im quite the risk averse person who believes in erring strongly on the side of caution. Feel free to do the math if you have the time.

In addition, for those who are unaware, i am not in the business of doing quarter prediction analysis. The total revenue and profit for Opensys is likely to be quite lumpy, from the ESM/Hardware sales.

The main goal for this bit of research, is to show and understand the SSS revenue and profit for the CRM business.

Do let me know if you have any comments.

Disclaimers: Refer here.

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Facebook: Choivo Capital
Website: www.choivocapital.com
Email: choivocapital@gmail.com

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