Aztech Systems

Blue sky scenario
Aztech Systems (Aztech) is at the sweet spot of a demand
cycle driven by rising broadband adoption, product
replacement cycle fuelled by 802.11n wireless
technologies, new web technologies, rising IPTV adoption
and more connected homes. New outsourcing contracts
from key customers would be ‘icing on the cake’.
Market share gains
Aztech is an internet enabling device ODM, which has a
large and diversified pool of customers that extends across
the world. Starting from a low base with an estimated 2.2%
market share globally, it is set to capture market share
through increasing orders from two key customers: one is
shutting down production in US and shifting to outsourcing,
while the other is receiving new orders from its customers.
Entering its fifth consecutive year of earnings growth
Aztech has seen 4
year CAGR earnings growth of 63.5%;
earnings should expand by 23% this year and 41% next
year. We believe earnings may see upside surprise if our
conservative order forecasts are exceeded. The stock,
although small among its peers, trades at an unjustified
50% discount to its peers’ current PER average. The stock
trades at 10.2x FY2007 PER and 7.2x FY2008 PER, which
makes it appealing to private equity (PE) and competitors.
We initiate with an OUTPERFORM, FV at S$1.02
Near
term catalysts include better
than
expected interim
results and better
than
expected order book. It also offers
value for investors seeking to leverage on the strong
secular internet and networking industries growth trends.
With backing from its customer base, an operation that
generates positive cash flow and the potential to be
earnings accretive for its suitors, there is added M&A
appeal. Our fair value pegs it to the exit valuation multiple of
GES International, which was acquired by VMS in 2006.

Aztech Systems is a SGX listed technology company with an operating record of more than 20
years. An innovative and resilient company, Aztech Systems (Aztech) has strong R&D capabilities
and has integrated manufacturing capabilities. It specializes in providing Original Design
Manufacturing (ODM) and Electronic Manufacturing Services (EMS) services to its diversified
customer base.
The Group is enjoying a sweet spot in the demand cycle for home and SME internet enabling
devices. Increasing broadband penetration, rising IPTV adoption rates, the soaring popularity of
the digital home, combined with increased outsourcing activities from some of its current
customers are boosting Aztech’s earnings growth prospects.
Trading at a sharp discount to its global peers and on low valuations, Aztech is appealing as a
M&A target. An acquisition by any one its peers would likely be earnings accretive, while cash rich
private equity (PE) firms would be attracted by earnings growth prospects and FY 2007 FCF yield
of about 6.6% and a dividend yield of approximately 4.9%. Our fair value for the stock is S$1.02.
An innovative and resilient technology company
Aztech Systems has been in business for the last 21 years. During this period, the Group was
once the second largest PC sound card makers after Creative Technology and one of the five
largest modem makers in the world. The Group’s operations plunged into losses for five
consecutive years in the late 1990s and early 2000s when it first started the manufacturing
business, lost key customers due to PC consolidation and later when it tried to ride the dotcom
boom with two internet initiatives. A painful business restructuring and a renewed business focus
have helped it to see a turnaround in 2003, and the Group’s performance has since propelled
forward, as it leveraged on its R&D strength to capitalize on demand for communication devices.
Sweet spot in the demand cycle
The Group is in the sweet spot of the demand cycle for internet enabling devices. Fast evolving
internet communication and wireless technologies coupled with a talented R&D team and
integrated manufacturing capabilities have attracted global telecommunication equipment
suppliers and service providers to use its products. With ongoing advances in web technologies
and the digital home, demand for larger bandwidth and faster data flow rate have motivated
Aztech to innovate and develop cutting
edge products. It has tied up with globally renowned
company
Skype
to develop communication devices based on its VoIP technology platform.
More outsourcing orders ahead
The Group expects to receive more orders from its key customers. Two of its key customers are
expected to award extra orders in H2 2007. One of its customers was recently acquired by a
global communications vendor and with an extended supply chain, it is seeing stronger demand.
The other US
based customer has announced plans to close down its manufacturing facility in
the US and increase its outsourcing activities. In addition to these, the Group has received orders
to build a HD TV set top box that has an ASP of US$250 from a customer in US, and will be
supplying its latest 200 Mbps AV Homeplug adapter to a Singapore telecommunications company
that is rolling out its IPTV services.
Diversified customer base and links with global telecom operators
The Group has built an extensive network of customers that is spread across the computer,
consumer and communications electronics sector. Its diverse product range and its long track
record in the business allows Aztech unrivalled access to these accounts. The merit of having a
large pool of potential customers is visible this year, when the Group mitigates the substantial fall
in order volume from a global microprocessor customer (for CPU test boards). Aztech’s strong
ties with telecom operators have also helped it stay ahead in developing products that meet their
requirements. More recently, it announced a R&D tie
up with Telecom Malaysia, a testament to its
strength and capability.