Saturday, March 31, 2012

Silverlake Axis - Part 5 (Conclusion)

Let's do a recap of what has been discussed thus far

Financial Statement Analysis

Very high profit margin of 35% to 65%
Profit margin might vary due to 4 different segment margin in the range of 25%, 40%, 65% and 90%. However, sales of hardware often constitute a very small part of total revenue.
Net cash no debt
High P/BV
High ROE
Its propriety software is worth much more than actual value, hence possibly inflating ROE.
Highly cash generative, high percentage of profits are converted into hard cash
Company has been doing buyback, acquisition due to chunk of cash at disposal.  Might not be able to generate positive ROI
Quarterly Dividend
Subjected to currency fluctuation as earnings are reported in MYR

Core Banking System Industry

Banks and vendors are likely to maintain a working relationship of at least 10-15 years due to the high cost high risk nature of changing a core banking system.
Similarly, SIBS might face difficulty in snatching customers from rival.
Maintenance contract will last for as long as banks continue using the software. Serve as a buffer in times of economic recession.

Maintenance contract has high profit margin of 65% and has potential to grow given that the industry standard for such contract is priced at 15-22% of initial licensing fee.

Licensing of SIBS is highly lucrative with a profit margin of 90%.
New contract will be difficult to get in time of recession though existing contract is impossible to be cancelled.

Silverlake Axis's Competitive Advantage

Silverlake Axis has a stronghold in South-East Asia, accounting for more than 50% of total transaction. Market leader in Singapore, Malaysia, Indonesia, Vietnam and Brunei.

Ability to leech on the growth of its customers especially in Malaysia and Indonesia. Expansion of branch as well as merger & acquisition will result in additional revenue.
Similarly, they face the risk of having their customers get acquired by others. Risk is mitigated by having the largest and most aggressive banks as their customers.
Pricing power proven with a 10% hike in maintenance fee during in current recessionary condition.

HNA’s deal is likely to lead to more projects for Silverlake given that HNA will hold around 10% of Silverlake’s share
Account for highest percentage of receivables.
100% implementation success as compared to rivals (Temenos and Infosys) who have failed in numerous projects.

QR Tech allows diversification from the finance sector.
Only account for around 10-15% of revenue presently.
Global Infotech in the process of listing.

Now, we have come to the most important question, is it too expensive at the current price of $0.355 and where is my margin of safety? Here is how I view this stock:

The most important thing is to split the company revenue into recurring (Maintenance and Enhancement Service) and project basis (all other business). For the recurring income, it is expected to be contributing SGD 38m profit for FY 2012, which means that if we are solely judging the business by this recurring income,  I will be paying for a PE of 20. 

So what do we do with project basis, do we simply discount it? The answer is obviously no, given that they represent profit and cash to the company just like other project based company like construction, property and system integrator.The way I have decided to treat them will be that it will be counted as part for the profit but should never be used as a projection for future order size. 

In 2011, Silverlake Axis started implementing its 4 projects seized in 2010 which totalled up to a sum of SGD 210 million. These 4 projects are SGD 70 million for HNA Group, SGD 30 million for OCBC upgrading project, a BIBD upgrading project and a CIMB implementation project. From here, we can easily deduce that CIMB project is worth at least SGD 90 million given that BIBD upgrading project is expected to be much smaller than OCBC which has a regional base. Of these, MYR 150 million of non-incurring income has been recognised in FY 2011.

Thus, there is still at least MYR 365 million of projects to be recognised over the next 3 years from 2012 to 2014. This is a conservative figure as it is assumed that smaller projects as well as bank expansion does not account for any cent in the MYR 150 million of non-recurring income. Other than these 4 projects, Silverlake Axis has also secured 2 integration project from the merger of Hong Leong and Eon bank as well as Thanachart and Siam City Bank. In total, Silverlake Axis currently should have around MYR 565 million of project to be recognised over the next 3 years. Splitting the sum equally among the 3 years and assuming a profit margin of 35%, we will have another SGD 27m in profit. This is estimated conservatively again given that SGD 160 million of the projects (HNA and CIMB) are implementation project which has much much higher profit margin. Thus we will have SGD 65m in profit for the next 3 years (assuming that maintenance income does not grow) which will be giving us a PE of 11.5.

So what will happen to Silverlake from 2015 onwards if it fails to secure any more contracts? Well, by then, Silverlake Axis will start to enjoy recurring income from HNA and CIMB Group project. 
15% * SGD 160m = SGD 24m
With a profit margin of 65%, that will give us 16m in additional recurring income.

Therefore, in 2015, recurring income will become SGD 54 million which will give us a PE of 13.8 on the assumption that Silverlake Axis fails to win any more contract for the next 3 years and that its customer never expand and engage in M&A activities. And in 2015, the new version of SIBS will be out, thus it is indeed very hard for Silverlake Axis not to secure any more contract for the next 3 years.

Personally, I do regret not having discovered the company 1 month earlier when it is below 30 cents, but I don't think that I am overpaying for it right now. There is no doubt that Silverlake Axis is an excellent piece of business with steady recurring income, as for what is the right price to pay, no one other than yourself should be the one making the decision.

Wednesday, March 28, 2012

Silverlake Axis - Mr Goh Peng Ooi (Supplementary)

As stated, this is a supplementary to the current report on Silverlake Axis before the final post this weekend. Carefully listen to this interview as it will give you an understanding of its history as Axis System as well as Mr Goh Peng Ooi's love for Math and his business view. I have also attached a newspaper article for your reference.

For part 1, it is about Mr Goh's interest and early life as well as his decision on the listing of the company.
For part 2, try to understand the complex adaptive system that he has been emphasizing about. Basically, it is a system where numerous individuals interact to produce a collective behaviour or properties - in such a case, looking at individual is pretty useless as the collective properties cannot be attributable to any of the individual.For e.g. ant colony, stock market and even human body.

Perseverance pays off.
New Straits Times
| March 13, 2006
Byline: Foo Eu Jin
GOH Peng Ooi, executive chairman of Silverlake System Sdn Bhd, is driven by passion and commitment. There's no doubt about it.

During his student days, he was passionate and very much interested in science and mathematics. He excelled in his study and was offered the Mombusho scholarship to study nuclear physics in Japan. He graduated in 1980 from the prestigious University of Tokyo with a degree in electronics. Upon graduation, Goh started his career with IBM. Again, his commitment and passion made him a sterling performer at Big Blue, receiving recognition for his many outstanding accomplishments.

In June 1989, he decided to venture on his own to set up Silverlake, a software development company.
With an excellent advanced state-of-the-art banking solution offering and through persistence and determination, the new company quickly secured several local banking clients. Soon, it clinched contracts with large banks in Singapore and Indonesia.

Today, Silverlake provides banks in many countries with seamless customer-centric branch automation and Internet banking solutions that have the ability to deliver complete banking functionalities across all channels in real time.

The company also provides a comprehensive suite of solutions to meet the requirements of Islamic banking.
Silverlake is undoubtedly one of the largest banking system developers and integration providers in Asean, serving customers spanning from Southeast Asia to China, Europe and the United States.

On the rudiments of banking software technology, Goh explains that it involves three key layers comprising customer's lifestyle, product and sustenance.

The lifestyle layer covers areas such as automated teller machine, mobile phone banking, credit card and Internet banking. This is followed by the product layer, which involves financial products such as housing or car loans.
The third layer, which is the sustenance layer, covers various laws of governance. 

Goh attributes the "symmetry" software design model for Silverlake's success in developing home-grown banking software applications. "We specialise in symmetry when developing software applications, and our model is based on mathematics and focuses on ensuring the customers' sustenance requirements," he explains.

The company's banking software model - which focuses on the sustenance concept - is based on the six pairs of factors, which, among others, include debit/credit, risk/return, asset/liability and income/expense factors.
Goh notes that Silverlake's programmers are not required to focus on the lower levels of governance, but more importantly, to ensure that the customers' sustenance requirements are met.

"We convert software development into science and deliver solutions based on the six pairs of factors. Thus, software development becomes simple, and we can easily train our people," he says.

According to Goh, the sustenance concept in banking also applies to the development of software for other industries such as airlines. Silverlake's innovative applications, he says, have even caught the attention of foreign information and communications technology companies.

On what advice he would give budding entrepreneurs to succeed, Goh sums it up in one word - determination.

Saturday, March 24, 2012

Silverlake Axis - Part 4 (Other businesses)

Before I start on Part 4, I will like to add on some stuff that has been missed out earlier, especially when part 3 is very long.
Silverlake Axis has a 100% successful implementation track record which is very rare given that an estimated 25% of all CBS projects “fail without any results” while another 50% do not meet their original objective. As the implementation project is often multi-millions, banks will definitely prefer one with a good track record.
Secondly, according to one of the DBS report, maintenance and enhancement service fee has been increased by 10-15% this year. This shows Silverlake’s pricing power especially when it is doing so in the current economic condition.
Now, we shall have a look at all other segments as well as its associates.
Customised Software Solution
This is provided upon request from the clients with the main aim of improving the CBS and installing add-ons so as to provide the bank with an added advantage over its rival. Profit margin in this area is around 40% which is much lesser than that of a maintenance and enhancement service. SIBS is a highly customizable platform where new features can be installed without changing a single line of program code once the system is installed.
Sale of software and hardware products
This segment constitutes the reselling of hardware and system software on which SIBS runs on. It is more of a complementary service to its core business of SIBS. Profit margin in this area is at 25% due to its long-term partnership with IBM.
QR Tech
They provide retailers with a system solution called “PROFIT” and constitute part of the recurring income. It is capable of connecting every retail store around the globe to one database, providing services like Inventory Management, Warehouse Management, Supply Chain Management as well as Account Receivables and Payable. Customers include Robinsons, John Little, ├ćON Co and Marks & Spencer. AEON is the largest retailer in the whole of Asia with a retailing group of 180 companies. Operating in Japan, China and South-East Asia, it has 590 general Merchandise Stores, 1307 Supermarkets, 3811 Convenience Stores, 3305 Specialty Store, 2657 Drugstores and 1410 Service Business. QR Tech currently accounts for around 10% of the Group’s total revenue.

Card Processing
Initially a joint venture with SBI Group, Silverlake Axis acquired the remaining 75% stake in 2010 for an amount of SGD 7.59 million dollars. Accounting for RM 16.5m in revenue in 2011, it suffered a loss of RM 3.9 million. Was the management wise then in acquiring SBI card, given that it was a loss making company? If one were to examine closer, the loss was an accounting loss but it does not create cash outflow. Amortization of intangible asset of RM 6 million was the main reason for the loss. However, do take note that it still creates a positive cashflow of RM2.1m and this amortization was not due to real impairment losses. This business is synergistic to its QR Tech and SIBS as AEON Group and Bank Rakyat Indonesia are also using SBI Card processing software. SBI group itself is using the processing service and has around 63000 card users as of 2010. This segment is still at a rather infant stage and has the potential to grow.

Global Infotech
Formed in 1998, the main purpose of the business is to provide IT solution for banks and financial institution in China. Till date, they have more than 90 clients in China using their financial software, being ranked number 4 in terms of market share of IT solution for financial institutions in China. In 2003, they received a joint investment of US 6 million from DEG, IFC and OCBC. Being a member of the World Bank Group, IFC provides loan and equity financing for the private sectors in the developing countries, while DEG is the German Investment Corp, owned by the government of Germany. Silverlake Axis’s total stake in it is 27% from its US 20 million investment in 2007.
As of 5th December, 2011, Global InfoTech has registered for consideration of listing in the China Stock Market and this will not only be capable of unlocking value for Silverlake but will also be able to fund Global InfoTech for its expansion.

A 24.5% stake was taken in it by Silverlake Axis for a sum of RM 24m in 2008. However, no cash was being spent in this investment in associates as the amount was eliminated from the purchasing of license from Silverlake Axis by ePetrol. ePetrol “pioneered an innovative payment system which uses the Malaysian National ID Card (MyKad) as the payment instrument for fuel purchases in petrol stations.” In short, it allows cashless payment without the issuing of a credit card as the National ID card is being used instead.
The last part will be summary and conclusion where the key points will be highlighted and valuation will be discussed.

Wednesday, March 21, 2012

Silverlake Axis - Part 3 (SIBS, The Source of All Profit)

Fig 1 Revenue by Segment

In this part 3, we will focus on how Silverlake Axis generates its revenue through its propriety software, Silverlake Integrated Banking Solution (SIBS). As such, I will only be touching on "Licensing of SIBS" and "Maintenance and Enhancement Services", which are its core business. The rest of the other businesses will be reserved for part 4.
For licensing of SIBS, it is a fairly simple business to understand. When a bank has decided to change its core banking system, the first step will be to build or buy? In the 1990s, many have tried to build a system themselves and this has proven to be a terrible and costly mistake. As such, in the current era, many especially the smaller banks will seek out a vendor to provide the solution. This is a very tedious process that will usually take a few years to complete and will be even more complicated should the bank has many branches.
This is a highly lucrative project whose profit margin has always been at least 90%. SIBS has already been developed as such the bulk of the cost comes from the software engineers that are hired to install and implement the solution. How much the total contract size will be is determined by the number of branches that a bank has and the type of business it is being involved. Thus, so long as its existing customers continue to expand the number of branches, it will be able to earn additional software licensing fee. However, in normal circumstances, the bulk of the revenue comes from new customers. Therefore, we need to recognise the fact that this source of revenue is contract-based, lumpy and usually one-off. This is also the main reason why Silverlake Axis has consistently been poorly valued, be it too high or too low. But the end of an implementation contract does not signify the end of all working relationship and profits, instead it just marks the start of an additional source of recurring income for as long as the bank continue using SIBS. (remember in part 2, it was concluded that the vendor and the bank are likely to stay engaged for at least the next 15 years?)
After the successful implementation of SIBS, a 6 months- 1 year warranty period is provided for the bank for free. After the end of the warranty period, a "maintenance" contract will be signed where the vendor will provide maintenance service to the bank for a fee. While it is called a "maintenance" contract, in reality, it is simply a form of license fee to continue using the software for the bank. So how are fees being charged? The industry standard for this annual maintenance fee is 15-22% of the original licensing fee for the software, which is what that makes the industry so lucrative. Or to put it in another way, the vendor will get to earn another full licensing fee after another 5-6 years. And of course, if the bank expands and incur more licensing fee, expect the maintenance fee to increase too. This is just the tip of the iceberg. SIBS will have a new global upgrade version after every 3-5 years and the last version was out in 2010, which means if a bank wants to upgrade the CBS version, it will have to pay another amount. (One can choose not to upgrade though)$file/Silverlake_Announcement_SIBS_Upgrade_Contract.pdf?openelement
I supposed this large regional bank should be none other than our OCBC, there's not many regional banks around whose upgrade contract can cost $30m...
With such lucrative business, will Silverlake Axis be capable of fending off its competitors, especially with the like of Tenemos, Misys, Infosys and Fidelity? Will it be able to fight against them to secure new contracts? Before I touch on this point, lets look at its existing customer base.
Singapore - OCBC and UOB. UOB uses their software since 1997 and has in fact been one of their most important client in their history. UOB was using an advance CBS from a US vendor but has decided to replace it with SIBS. This success allows it to secure further contracts from OCBC, May Bank, Hong Leong and Mandiri. To conclude, 2 out of 3 local banks in Singapore uses them. In case you are wondering what software DBS has been using that has been creating the most number of glitches in Singapore, they have been using Infosys Finacle since 2005. They even have a write-off during the implementation

Figure 2 - 8 Anchor banks in Malaysia

Malaysia - This is in fact its strongest ground given that it is a Malaysia company. 6 out of 8 anchor banks in Malaysia uses SIBS (those highlighted in Orange). Bank Islam the number 9 largest bank in Malaysia also uses SIBS, they are the oldest Islamic Bank in Malaysia. (Please correct me if I am wrong) Other customers include Employees Provident Fund (our equivalent of CPF) and Malaysian Airline System (their national carrier).
Fig 3 - Top 10 Banks in Indonesia

Indonesia is yet another stronghold of Silverlake Axis. The banking industry in Indonesia is very fragmented with more than 200 banks due to the low entry requirement to open a bank. Among the top 10 banks, 4 uses SIBS - Mandiri, Bank Rakyat Indonesia, CIMB Niaga and BTN. Coincidentally, Mandiri, BRI and BTN are 3 of the 4 state-owned banks (the last one is BNI). Just these 4 customers account for 32.1% of market share in Indonesia. Silverlake's other customers include - Mega (11th), OCBC NISP (13th) and Buana (14th).
Vietnam - Vietcombank (3rd largest), BIDV(2nd largest), IncomBank (4th largest now known as vietinbank) and Maritime Bank (6th largest). Vietcombank, BIDV and Incombank are 3 of the 5 state-owned banks in Vietnam.
Brunei - Bank Islam Brunei Darussalam Berhad (BIBD), Perbadanan Tabung Amanah Islam Brunei (TAIB). TAIB and BIBD are 2 of the only 3 local banks in Brunei
Sri Lanka - People's Bank, largest in term of network and 2nd largest in Sri Lanka. It is once again another state-owned bank.
Philippine - UCPB (10th largest), Bank of Commerce (13th), PBCom (19th), Robinsons Bank (23rd, it is the largest thrift bank too) and Premiere Bank
Thailand - Thanachart Bank merge with Siam City Bank to create the 5th biggest bank in Thailand.
HSBC Amanah - Largest Islamic financial Service from an International Bank. 8th largest non-government Islamic Finance Institution.

Fig 4 HNA Group
China - Commercial Bank (9th largest), HNA Group. Global Infotech (22% stake in it) - 90 clients in China, notably 2 state-owned bank - China Agricultural bank and ICBC. But what's the most interesting here is its partnership with HNA group.
As seen above, HNA group is a big conglomerate that involved in retail, finance, airline, property, shipping, airport, logistic and e.t.c. It is a rather mysterious group due to its size and scope, but is not a state-owned enterprise. It is one of the 7 airlines to be ranked as a 5-star airline globally and have total asset of 160 billion RMB. Controlling numerous airline, it forms the Grand China in 2007, with George Soros having a 18.6% stake in it. HNA has numerous substantial stake in Beijing Capital Airlines, Lucky Air, Zest Airways, Tianjin Airline, Yangtze River Express, Hong Kong Airlines and Hong Kong Express Airways. Why did HNA Group chooses Silverlake Axis- because they are able to provide software solution for finance, retail and airline as well as in card processing.
The SGD 70m contract announced in 2010 is fortunately unlikely to be the last contract that they will secure from HNA Group.$file/SAL.HNA.Strategic.Alliance.Annoucement.9July2010.pdf?openelement
Shortly, in June 2010, Mr Goh Peng Ooi entered a structured share sale agreement with HNA Group where a total of 11.57% of issued shares will be sold by Mr Goh to HNA Group over a 3 years period at a price of $0.16. The price of $0.16 will be fixed should the price increases, but if the price drops, Mr Goh will then have to sell those shares at the lower price instead. For Mr Goh to undergo what seemed like a short-changed deal, obviously this strategic partnership is going to develop to much more contracts in the future or perhaps something more than just 11.57% shareholding.
From the above, it naturally gives us one conclusion - Silverlake Axis has a very strong position in the South-East Asia region especially Singapore, Indonesia, Malaysia, Brunei and Vietnam. Let's have a look at some statistical evidence.

Fig 5 - Inntron Core Banking System Ranking

Fig 5 is a ranking of the top 10 CBS vendor globally. From the above, we can see that there's 5 USA firms, 2 India firms, 1 UK firm and 1 from Switzerland. For Silverlake Axis to get into the top 10 in the world is very impressive for a firm that has usually been operating only in the South-East Asia Region. Of course, there is no point being in the top 10 if 9 other competitors are ahead of you.

Fig 6 Ranking of Islamic Banking Solution
Silverlake Axis comes in at an impressive number 3 position, which is not surprising given its strength in Malaysia and Indonesia.
Fig 7 Top 10 in Asian Regional Market
Silverlake Axis is ranked number 4th in the whole of Asian regional market. From the above 3 rankings, it seemed like Silverlake Axis is not that strong in Asian and Islamic Banking, with Temenos and Oracle consistently coming in front of it.
What I believe is Silverlake Axis's true competitive advantage lies in South-East Asia, Islamic Banking as well as in small-tier and mid-tier banks. For South-East Asia, it is in fact very clear that there's no other vendor whose operation comes close to it. The closest competitor in this area is Infosys's Fidelity. Being stationed in Malaysia and its 20 years track record of successful implementation in major banks in Singapore, Malaysia, Indonesia, Brunei and Vietnam, these explain its stronghold in South-East Asia. Other than this, it is able to integrate its Islamic Banking solution with its SIBS, as well as providing other services like card processing for the like of Bank Rakyat Indonesia.
Another point to note is that Silverlake Axis will never implement a full scale solution for the likes of HSBC, Barclay Group, CitiBank and Deutsche Bank. Silverlake Axis has always been focused on small bank and mid-tier regional bank like OCBC, UOB, Maybank and CIMB.
And the question now will then be why should one be invested in Silverlake Axis and not Oracle, Fiserv or Temenos? The answer again lies in its stronghold in ASEAN. Among the global banking industry, banks in South-East Asia has one of the strongest balance sheet to withstand any financial crisis after having been through the 1997 AFC. They are also poised for growth with the banking scene of many like Indonesia and Vietnam being undeveloped. For the more developed one, regional bank like Maybank and CIMB are actively acquiring and expanding. As noted above, an expansion of branch will result in additional licensing fee and hence the Maintenance and Enhancement fee as well.
Countries like Malaysia and Indonesia are also liberalizing their banking sector and hence consolidation is expected. In any M&A, it is very likely that the acquirer will have its CBS imposed on the acquired. This can be a double-edged sword for Silverlake Axis, because if its customers got acquired, it may lose its maintenance fee. However, with the biggest banks in the region as its customers, it is more likely to gain more customer than to lose them. Last year, Silverlake Axis was so close to getting its hand on the 5th biggest bank in Malaysia, RHB, in a deal that reminds many of the consolidation happening in Singapore in 2001. Banks in Malaysia and Indonesia has been very aggressive of late.
There's 3 points that we have established in this post
  1. CBS is a highly profitable deal, with a 90% profit margin for the initial licensing fee, followed by a generous sum of recurring income for as long as banks continue using the software.
  2. Silverlake Axis is a market leader in South-East Asia, no other vendor is anywhere near it.'
  3. Hence, it will get to leech on the growth of the South-East Asia banking industry as well as the liberalization going on in Malaysia and Indonesia.
Part 4 will be on All Other Businesses of Silverlake Axis like SBI Card Processing, sales of hardware, Unisoft, QR tech and e.t.c

Sunday, March 18, 2012

Apple - US$960?

Could Apple reach $960? Possible. I don't mean to say that PE will rise by 60% as I am not a fortune-teller but for revenue and profit to rise by 60%, why not? Before we go about why it can reach $960, let's examine its growth driver in the past 4 years.

Fig 1 Revenue by Segment

A quick glance and every single figure is increasing year on year other than ipod. Mac sales increases by around 25% yearly as a result of perhaps brand loyalty coming from iphone and ipad. Ipod is on a downtrend due to the redundancy in having a iphone and ipod at the same time. Most other figures contribute insignificantly to its overall growth. It can be easily seen that the main reason for its revenue growth comes from iphone and ipad. Since 2008, iphone has been doubling yearly and has been the lead driver in profit growth. As for ipad, it was another great growth booster as a new product that contribute 20% to the topline in just 2 years. Therefore, to understand how Apple can continue its growth, we should look at both iphone and ipad.

The reason for the spike in ipad is due to the number of countries that they have distributed to. There is still plenty room for growth for ipad given that if a country has the necessary infrastructure to support iphone, it will be able to support ipad. Thus, I definitely don't see any reason why ipad cannot increase by another 50%. In fact, I do believe that it is not of a problem for ipad to double in sale. The key here is that we should not see ipad as an attempt to replace PC, laptop or whatsoever it is. Ipad is creating a market of its own called the tablet market. The main purpose of a tablet is a portable device that delivers all-round entertainment + surfing the net+ educational purpose. As for work purposes, I will say it may be able to snatch a bit of market share, but do not expect people to be throwing their PC or laptop away just for an ipad. Just with the ipad, total revenue can already grow by another 15-20%.

As for iphone, can the sale figure double again? Personally, I don't feel that Apple is able to win much more market share, perhaps just another 10-15%. The competition is too fierce for Apple to be able to secure customers from its competitor. Blackberry has a niche market of its own while you can have smartphone that are cheaper and more functional to cater to another group of people. A Microsoft and Nokia combination can be pretty dangerous too. Thus, it could be really hard for Apple to double its iphone sales by doubling its market share.

However, as in the case of ipad, we might actually be focusing on the wrong perspective - that of Apple securing market share from its competitor. Perhaps, we should be looking at the prospect of smartphone vs the non-smartphone. Gartner estimated that 2011 total smartphone sales worldwide is 472 million or 31% of all mobile communication device sales which stand at 1.5 billion. A smartphone having just 31% market share is simply too low even if we take into account that it is not in every country that you can enjoy 3G or data roaming. Smartphone is simply a irreversible trend that so long as the infrastructure is there and the price is not too expensive it will continue to spike up. Anyone that uses a smartphone will understand why - Connectivity on the go, GPS, Unlimited games and apps, Stock trading and e.t.c.

As such, JPMorgan predicts that 657 million smartphone will leave stores in 2012. IDC predicts sale to rise to 982 million by 2015 and IMS expects smartphone to rise to 1 billion annual sale. Such a trend is not only driven by the fact that smartphone will gain more market share, but also by increase in population(7 billion currently) and rise of the emerging countries where phone penetration rate is still low. Thus, so long as Apple is able to hold its market share well, it is pretty easy to see why Apple is able to double its iphone sales in the next 2 years. With that, you have another 40% growth in revenue.

The above table is the average selling price per unit derived through dividing total revenue by total unit sold. While Apple control significant mind share, the unit price shows otherwise. From 2008 to 2011, price of iphone only increases by 13%. This does shows the intense competition that Apple is facing from all-round, from Android down to the unbranded created in China smartphone. Thus, for it to increase its ASP to increase revenue and profit margin might not be very possible.

Apple has never been scared of cannibalizing on its existing sale and has been successful with iphone and now ipad. Will it be as successful with an iTV in creating another new revenue source? It may be able to increase revenue in the short term, but i highly doubt that it can be a game changer. If iTV were to be successful, it will definitely be able to create a new revenue source, but one that's short lived. Firstly, it is very possible for a family of 5 to have 5 ipads or iphones, but not for them to have 5 iTV unless they are very rich. Secondly, while we may change our phone year in year out, an average family is unlikely to do that with a TV. It should be able to lead a growth in revenue for another 2-3 years but for it to persist longer than that a subscription service will then be needed.

To sum up, a 70% growth in revenue is achievable with growth from ipad, iphone and iTV. Thus, so long as the market continues to price Apple at its current P/E, US 960 is definitely possible. We should not assume that Apple is no longer agile just because no corporation has been able to continuously grow at double digit at US 500bn market capitalisation in the past. Though I have to admit that this was why I did not look at Apple's figure when its share price was at $300. However, reversion of mean in terms of PE will always occur as our Mr Market is never forever optimistic. When revenue increases by another 70%, it will then be really hard for Apple to continue growing at this rate unless it is able to offer another successful product without the presence of the visionary Steve Job.

(not vested)

Saturday, March 17, 2012

Silverlake Axis - Part 2 (Understanding the Core Banking System Industry)

Fig 1 Silverlake Axis Integrated Banking Solution

The most important question that will come to everyone's mind when we talk about Silverlake Axis will naturally be what is a Core Banking System (CBS), is it just a software like your Adobe or Office? This will be what this whole post will be about.

The "Core" in the CBS refers to Centralized Online Real-Time Exchange, something like your trading platform where information is updated Real-Time. Gartner defines CBS as "those applications responsible for processing and posting transactions in the domains of payments, current and saving accounts, loans and securities (such as performing current and deposit accounting, maintaining loan accounts, holding securities positions, clearing payments)." Basically, as seen from fig 1, it is a centralized system that handles every aspect of the bank's business. When you deposit your money into the bank, CBS will update your main account and distribute the information to your ATM, credit card, credit risk, customer information and e.t.c. I will treat it as the human brain that's in charge of processing of all information received from the five senses and that exert a centralized control over the body.

Changing a core banking system has been treated as a high risk, high cost and high reward project. Cost saving is often not a sufficient reason for bank to change them. The risk and cost comes from the fact that an error can damage the reputation of a bank as seen from the numerous debacles that DBS has got itself into. Changing the system also requires the old system to be put down before the new system is being put up, and this will create downtime for the bank. All the employees in the bank will also need to be re-trained and it will be sometime before they can get used to it. Cost of the project is often high and project overrun is normal due to the numerous constrain involved and that it will often has to be done only in the weekend.

Kevin Lomax, the erstwhile chairman of Misys – one of the largest independent software vendors (ISVs) focusing on the financial services industry – was once quoted as having said: “Changing a core banking system is like replacing the engine of a Boeing aircraft mid-flight.”

“The challenge of replacing a bank’s core IT systems has been equated with everything from open-heart surgery to replacing the engine in a moving car. It is without a doubt one of the most difficult and complex challenges a bank will ever face, with implications that cut across functions, products and geographies.”
The above is an example of the impact of changing the CBS for CIMB Singapore, which only has 2 branches here.

Given the high risk high cost proposition, it is expected that many banks will not undertake such a project unless it is no longer a choice of theirs. As such, an adoption of a new CBS in a bank is likely to last them for at least the next 15 years and more. Please take note of this point as this is going to be the important for Part 3 later.
"While other system replacements tend to cycle every 5 to 10 years, a core banking system is expected to deliver capabilities and value for at least 15 to 20 years. Core systems are often viewed as a “once-in-a-lifetime” investment akin to a major factory replacement."
If that's the case, why are the banks starting to change their core banking system given the extreme high ROI needed to convince them? The answer is simple - survival of the fittest. There is no doubt as to the stickiness of CBS in a bank given that many banks are still using the old legacy system that date back to the 1970s and 1980s. Thus, these old systems are increasingly unable to meet the demand in today's world.

The ineffectiveness of the old legacy system is expected to cost banks in mature markets approximately US$200 billion annually according to the IBM Institute for Business Value Analysis. Up to 79% of a bank's IT spending are sometimes being used to maintain the old legacy system. This is just part of the reasons.

Increased regulation in the form of Basel III and other standards require a higher standard of information reporting as well as integration of the system. The wave of consolidation and M&A has also resulted in banks having multiple core banking systems that just add to the cost and the complexity of the demand today. So have most of the engineers that have been maintaining the old legacy system retired and it is harder to find people to fix the old system. Competitors that have done so have also proven to be leaner, faster and more efficient, and have managed to cut down on their IT spending. Thus, the time has come such that many of the old systems are to be overhauled since 2005.

Despite the current economic turmoil, Ovum's "Retail Banking Technology Spending Model through 2016" has predicted that global spending on retail banking technology will increase by $3.6bn (3.2%) in 2012 and will hit $135bn over the next five years. Banks in emerging economies in the Asia-Pacific region will grow the fastest at a rate of 8.3% in 2012. Therefore, room for growth in the banking technology market is still plentiful especially in Asia.

Part 3 will be on Silverlake's core revenue generation - Software implementation and Maintenance and Enhancement Service as well as its competitive advantage.