Is SPIL a right choice for FOXCONN to acquire in the packaging industry?

Presented by David Huang,

Biz Pro 9th Junior

Is SPIL(矽品) a right choice for FOXCONN (鴻海) to

acquire in the packaging industry?

December 26th, 2015

Executive summary

Foxconn should buy SPIL at this great time.

2

ACCEPTFoxconn acquires 21.21% shares of SPIL with

exchange ratio 2.34 : 1

Strategic Aspects

• Achieve the industrial

success factors

• Fit vertical integrated

one-stop model

• Leverage SPIL’s global

distribution channel

Client Aspects

• Share complement

clients like Apple Inc.

• Leverage knowledge in

packaging & clients

Financial Aspects

• SPIL is undervalued

• Synergy from stronger

growth, cost reduction,

and sales accretion

• EPS dilution is the main

concern for SPIL

BizPro 9th

3

1. Strategic Analysis

BizPro 9th

Large market shares and low production cost

are key success factors in the semiconductor industry.

BizPro 9th 4

• Both are sellers’ markets

• Profitability comes from

market shares & low cost

Profit = Price x Quantity - Cost

(P) Higher selling price (x)

(Q) Large market share (v)

(C) Low production cost (v)

Product-Focus Market

Source: Independent research.

EMS and semiconductor industries have both product-oriented markets.

EMS Industry Semiconductor Industry

Clients 3C product firms 3C product firms

Task Produce ECs, Package and Test Produce IC/Wafer, Package and Test

Key\

Factors

Market Share, Cost Reduction, and

Production Capacity

Market Share, Cost Reduction, and

Production Capacity

The eCMMs one-stop shopping model leads to the largest

market share and a higher gross margin in EMS industry.

BizPro 9th 5

eCMMs電子零組件垂直整合 Foxconn

GM 7.14% Market share 40%

OEM貼牌代工 Compal (仁寶)


ODM Quanta (廣達)


EMS 電子零組件製造 Flextronic


• One-stop shopping

• Global distribution

Product

Developing

Small-scale

Production

Large-scale

Production

Global

Distribution

Global

Repairment

The acquisition of SPIL fits the vertical integrated

one-stop shopping business model of Foxconn.

BizPro 9th 6

Vertical integration is the trend in

the semi-conductor industry.

“One-stop” business model, emphasized

in annual reports of semi-conductor firms,

is achieved by “vertical integration.”

• Qualcomm(高通) buying CSR (2015)

and Wilocity (focusing on IoT industry)

• TSMC developing the INFO SiP

technology (entering packaging

market)

• ASE focusing on integrating EMS

market and packaging services

IP Design /

IC Design

IC / Wafer

Manufacture

Packaging/

Testing

Socle 虹晶

Fitipower 天鈺

Foxisemicon 京鼎

Shunsin 訊芯

SPIL 矽品

Acquiring SPIL complete the

one-stop shopping model

Getting SPIL offers speed and mobility, attracts foreign

clients, and decreases production cost.

BizPro 9th 7

SPIL’s office and manufacture factory

Foxconn-related semi-con firms’ office

US: $65.7 B

Asia Pacific:

$194.2 B

Japan:

$35.2 B

Europe:

$38.5 B

• Buying SPIL to achieve cooperative design (faster to start production & better services),

two-place manufacture (lower cost), and global distribution (more flexibility)

Source: Independent research and

companies’ websites.

8

2. Client Analysis

BizPro 9th

SPIL’s offers products with similar terminal applications

to products of Foxconn and its sub-companies.

BizPro 9th 9

Product Terminal Application

覆晶晶片尺寸式

積體電路(FCCSP)

Mobile phone, tablet,

wireless internet card

覆晶式球柵陣列

積體電路 (FCBGA)

Computers, tablets,

IoT devices

晶片尺寸式

積體電路(CSP)

Wearable & IoT

devices, mobile phone

系統級封裝

(System in

Packaging)

Wearable & IoT

devices, mobile phone

Main products of SPIL Strategic Allocation of Foxconn

Shunsin focuses on

developing SiP tech.

High Technological Barriers

• Package RF IC, I/O IC, and

others in the same time

• Increase yield rates by

separately produce different

sizes of ICs

SPIL and Foxconn’s subsidiary company can

create win-win situation in packaging market.

Customized Production

• Knowledge about system

requirements of different firms

• Integrated Design (one

computer architecture in a small

chip)

BizPro 9th 10

Customers from

Foxconn

Large-scale

Packaging

BizPro 9th 11

3. Financial Analysis

EV = 6.6909 EBITDA - 0.2923

R² = 0.9213

0

10

20

30

40

50

0 1 2 3 4 5 6

En

terp

rise

Va

lue

(N

T$

B)

EBITDA (NT$ B)

Prediction on EV with respect to EBITDA

12

It is a great buying point for Foxconn since SPIL is

currently undervalued by $6.57 per share

SPIL’s forecast EBITDA in 2015 suggests a higher market value of equity.

EV from the model is

NT$ 18.4 B.

Current EV is

NT$ 16.4 B.

• Current price (8/28) is 39.5, but the target price for SPIL is NT$ 46.07

(undervalued by NT$ 6.57) under the current EBITDA forecast in 2015

Source: Independent research. BizPro 9th

2.75

BizPro 9th 13

SPIL’s exchange ratio 2.34 : 1 (implied price NT$ 40.03)

is reasonable and attractive for Foxconn.

Average EPS

in 2 years

• Focus on two companies‘ future earning performances

• NT$8.06 : NT$2.83 = 2.85 : 1

Average BV per

share in 2 years

• Focus on book values of two companies’ common stocks

• NT$63.98 : NT$21.6 = 2.96 : 1

Average MV per

share in 60 days

• Focus on market values of two companies’ common stocks

• NT$93.49 : NT$40.03 = 2.34 : 1

The ratio 2.34 : 1 (with implied buying price $40.03) is

reasonable from the above 3 pricing methods.

Source: Announced slide from SPIL.

BV: book value, MV: market value.

$154 B

$15 B$6 B

$6 B

$181 B

$-

$20

$40

$60

$80

$100

$120

$140

$160

$180

$200

Pre

se

nt V

alu

e (

NT

$ B

)

14

SPIL’s value will increase because of synergies,

which is beneficial for Foxconn.

Growth

Synergy

Cost

Reduction

Original

Value

Sales

Accretion

New

Value

• Build new gold wire bonding

production line

• Develop new SiP technology

• Leverage Foxconn’s automatic

production service

• Lower cost for equipment

• New SiP productivity of SPIL’s

derives the market share

• Customer sharing effects

SPIL’s Value Creation from the Acquisition


NT$ 27 B

(17.5 %)

15

No strong EPS dilution for Foxconn, but for SPIL share

it’s an important concern.

3.82 3.84 3.83

3.17 3.173.53

0.00

1.00

2.00

3.00

4.00

2016(F) 2017(F) 2018(F)

SPIL's EPS Dilution

Before Acquisition After Acquisition

8.378.17

7.978.19

8.007.80

4.00

5.00

6.00

7.00

8.00

9.00

2016(F) 2017(F) 2018(F)

Foxconn's EPS Dilution


The EPS dilution is significant for SPIL

for the NT$ 336,492 M (21%) equity.

The EPS dilution causes little impact on

Foxconn for the 2.2% raising equity.

• Should be careful that SPIL’s shareholders may be opposed to the acquisition.

• One reasonable solution is to set exchange ratio as 2.05 - 2.15 : 1 (NT$ 43.7 - 45.7)

(95% confidence interval for SPIL’s target stock price by DCF synergy model)


16

Recap: Acquiring SPIL fits Foxconn’s strategy,

shares their customers, and financially profitable.

BizPro 9th

Strategic

Analysis

1 • Achieve the industrial success factors

• Fit vertical integrated one-stop shopping model

• Leverage SPIL’s global distribution channel

Client

Analysis

2 • Sharing customers like Apple and Intel

• Leverage knowledge in SiP packaging and clients’

needs for their own products

Financial

Analysis

3 • SPIL’s is current undervalued by $6.57 per share

• Create positive synergy (NT$27 B) for SPIL

• EPS dilution problem is the main concern

Key Issues Analysis Results

17

Thanks. Any Question?

BizPro 9th

Appendix 1 -

Companies held by Foxconn in semiconductor industry

18

Equipment

IP Design /

IC Design

IC Manufacture

Wafer(晶圓) Manufacture

Mask Materials

Packaging/

Testing

Equipment &

Material

• Fitipower 天鈺 (1995)

• Foxisemicon 京鼎 (2001)

IC Manufacture

Manufacture Equipment

• Shunsin F-訊芯

(2008)

Packaging & Testing

• Socle 虹晶

(2001)

IP Design 1

2

3 4

The number in the circle

represents the founded order.

BizPro 9th

Appendix 2 -

Oligopoly market suggest not to use the “low-price” strategy.

BizPro 9th 19

EMS, foundry, and packaging market have the

same oligopoly industrial structure.

• Kicked-demand curve

• Sticky price behavior

• Hurt when price war occurs

Oligopoly Market

39.7%

14.1%

53.7%

37.1%

9.6%

10.9%

9.9%

22.4%

8.7%

5.4%

9.4%

19.6%

7.6%

4.7%

5.4%

11.4%

8.0%

4.4%

4.2%

9.5%

26.5%

60.5%

17.4%

0.0%

0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0%

EMSMarket

IC Design

FondaryFrim

Packaging &Testing

Market share

FoxconnPegtron

Quanta

Compal

Flextronic

Others

IntelSamsung

QualcommMicron

SK HynixOthers

Others

Others

TSMCUMCGlobal Foundries

SamsungSMIC

ASE GroupAmkor

SPILStats Chip PAC

Power Tech

Price

Quantity

Supply

Demand

Price War

Supply

Lower price cannot

largely increase the sales.

Source: Gartner (2015/04).

Appendix 3 - EV/EBITDA Multiples of Packaging and Testing

Firms in Taiwan, 2010 - 2014

20Source: TEJ Finance Database.

Company 2010 2011 2012 2013 2014

2311 日月光 17.6 4.1 6.4 7.0 7.4

2325 矽品 8.8 5.8 5.9 7.1 6.5

6239 力成 7.5 3.8 4.4 6.5 3.9

6147 頎邦 9.9 4.6 3.6 6.7 7.2

2449 京元電 7.1 2.8 3.1 4.4 5.2

8150 南茂 1.2 4.2 2.3 3.9 4.7

8110 華東 4.4 4.9 6.0 4.4 3.8

2329 華泰 10.5 7.6 11.7 10.4 8.8

2441 超豐 6.7 3.2 5.3 3.7 4.5

3264 欣銓 7.0 2.9 3.4 4.2 4.4

6257 矽格 5.2 2.5 3.1 4.6 4.7

8131 福懋科 2.2 5.1 3.8 2.5 3.1

2369 菱生 7.1 2.9 3.6 5.0 6.1

1437 勤益控 12.5 39.5 25.2 -64.7 17.8

3374 精材 11.7 6.9 5.7 8.3 7.7

6261 久元 8.3 3.6 4.9 6.5 5.6

3372 典範 8.2 4.5 5.7 53.8 10.3

3265 台星科 6.8 2.0 1.7 6.2 5.4

3559 全智科 0.4 3.1 1.9 2.4 3.4

8079 誠遠 8.7 2.0 2.1 2.8 2.5

5344 立衛 5.4 4.5 5.3 19.0 -21.8

6238 勝麗 -2.1 -8.0 -17.5 3.8 44.0

3567 逸昌 2.5 2.1 3.0 3.1 3.2

5455 訊利電 6.4 -15.3 -5.9 -9.9

BizPro 9th

Appendix 4 -

Rationale for using EV/EBITDA model


Large variability of tax-rate for same P/E

BizPro 9th

0

10

20

30

40

50

60

70

80

0 10 20 30 40

P/E

Ra

tio

Tax Rate (%)

Tax Rate versus P/E Ratio of Packaging Firms in 2014

Similar P/E ratio, quite

different tax rate

Large variability of debt ratio for same P/E

0

10

20

30

40

50

60

70

80

0 50 100P

/E R

atio

Debt Ratio (%)

Debt Ratio versus P/E Ratio of Packaging Firms in 2014

Similar P/E ratio, quite

different capital structure

Appendix 5 -

Relative-pricing regression model – EBITDA versus EV


Regression Coefficients

Coefficient Standard Error P-value

Intercept -0.2923 0.1761 0.10

EBITDA 6.69 0.180025 0.00

Goodness-of-fit Statistics

R-square 0.92

Adjusted R-square 0.92

Standard Error 17230.78

# of Observations 120

Important Summary Statistics Regression Line

BizPro 9th

EV = 6.69 EBIDTA - 0.2923

R² = 0.9213

0

10

20

30

40

50

0 2 4 6E

nte

rprise

Va

lue

(N

T$

B)

EBITDA (NT$ B)

Regression Line

Appendix 6 -

Key financial information of SPIL in 2014


Income Statement Information (NT$ M)

2014(A) 2013(A)

Current EBIT = $ 14,659

Current Interest Expense = $ 403

Current Capital Spending $ 10,559

Current Depreciation & Amortization = $ 12,436

Tax Rate on Income = 18%

Current Revenues = $ 83,071

Current Non-cash Working Capital = $ 12,924

Chg. Working Capital = -$ 30,520

Cash and Cash Equivalent $ 30,156

Book Value of Debt = $ 57,639 $ 39,340

Book Value of Equity = $ 72,112 $ 62,470

Market Capital Information

Market price per share = $ 39.50 NT$

& Number of shares outstanding = 3116361 # (張)

& Market Value of Debt = $ 57,639 NT$ M

Debt to capital ratio to be used 35% %

Costs of Capital Components

Market Return (1 year) 10.70%

Beta (1 year) 1.19

Risk-free Rate (1 year) 1.18%

Cost of Equity = 12.50%

Cost of Debt = 2.02%

Earnings Inputs

High-growth Phase Growth rate 1.46%

Stable Phase Growth rate 1.46%

Return on Capital

Return on capital in perpetuity 6.07%

1. Cost of equity is estimated by the CAPM in 2014.

2. Cost of debt = average 2 year corporate bond yield in

2014 + corporate risk premium.

3. Growth rate is estimated by t5-year sales CAGR.

4. Return on capital in perpetuity is estimated by the

current ROA minus the GDP growth rate.

BizPro 9th

Appendix 7 -

DCF valuation of SPIL before Foxconn’s acquisition

24

Present Value of Future FCFF During Stable Period

Growth Rate in Stable Phase = 1.46% %

FCFF in Stable Phase = $ 9,428 NT$ M

Cost of Equity in Stable Phase = 12.520% %

Equity/ (Equity + Debt) = 55.58% %

AT Cost of Debt in Stable Phase = 1.66% %

Debt/ (Equity + Debt) = 44.42% %

Cost of Capital in Stable Phase = 7.70% %

Value at the end of high-growth phase = $ 151,276 NT$ M

Final Valuation Result

Present Value of FCFF in high growth phase = $ 13,132 NT$ M

Present Value of Terminal Value of Firm = $ 140,467 NT$ M

Value of the firm = $ 153,598 NT$ M

Cash and Cash Equivalent $ 30,156 NT$ M

Market Value of outstanding debt = $ 57,639 NT$ M

Market Value of Equity = $ 126,114 NT$ M

Preferred Stocks $ - NT$ M

Market Value of Equity/share = $ 40.47 NT$


Appendix 8 -

DCF valuation for growth synergy of SPIL after acquisition

25Source: Independent research.

Key Assumption

• SPIL will experience 3-year high-growth

phase due to new techniques

• Revenue growth rate has mean 2.46% and

volatility 6.50% from past data estimation

• Revenue growth rate has a normal

distribution

Mean

$15,111 M

Projected Present Value of Future FCFF During High-growth Period (NT$ M)

2016(F) 2017(F) 2018(F)

EBIT * (1 - tax rate) $ 12,361 $ 12,665 $ 12,976

- (CapEx-Depreciation) -$ 1,923 - $ 1,970 - $ 2,018

- Chg. Working Capital $ 318 $ 326 $ 334

Free Cashflow to Firm $ 13,965 $ 14,309 $ 14,661

Present Value $ 12,966 $ 12,337 $ 11,738

Std. Dev.

$8,216 M

BizPro 9th

Appendix 9 -

DCF valuation for cost reduction and sales accretion

26

Cost Reduction Key Assumption

• SPIL’s cost will reduce due to Foxconn’s

automatic manufacture experience

• Assume cost will reduce averagely 1% per

year, and the volatility is 0.44%

• The cost reduction rate per year has a

normal distribution

Mean

$6,921 M

Sales Accretion Key Assumption

• SPIL’s sales revenue will increase by

sharing customers with SPIL

• Assume sales will increase 0.50% after 3

years, and the volatility is 1.17%

• The sales increase rate has a normal

distribution

Mean

$6,632 M

Source: Independent research.

Std. Dev.

$945 M

Std. Dev.

$1,378 M

BizPro 9th

Appendix 10 -

Forecast P&T market size and SPIL’s sales accretion impact

27Source: Gartner & Independent research.

Professional P&T Forecast

Item 2016(F) 2017(F) 2018(F)

Total Market Size (NT$ M) $ 1,846,336 $ 1,817,790 $ 1,919,430

Professional P&T Percentage 51.30% 51.90% 52.60%

Increase SPIL's Market Share 0.00% 0.00% 1.00%

SPIL's Revenue Impact (NT$ M) 0 $ 0 $ 10,096

SPIL's EBIT Margin (NT$ M) $ 17.65% 17.65% 17.65%

SPIL's EBIT Impact (NT$ M) $ 0 $ 0 $ 1,782

Increasing SPIL's EBIT (1- tax rate) (NT$ M) $ 0 $ 0 $ 1,466

Sales Accretion Key Assumption

• SPIL’s sales revenue will increase by sharing customers with SPIL

• Assume sales will increase 0.50% after 3 years, and the volatility is 1.17%

• The sales increase rate has a normal distribution

BizPro 9th

Appendix 11 -

EBIT forecasts of SPIL after acquisition

28

SPIL's Target Stock Price

Current Target Price $ 40.47

Future Target Price (after dilution) $ 45.83

Original EPS Forecast 2016(F) 2017(F) 2018(F)

EBIT (NT$ M) $ 14,873 $ 15,091 $ 15,311

EBT (NT$ M) $ 14,469 $ 14,526 $ 14,521

Net Profit (NT$ per share) $ 11,908 $ 11,955 $ 11,950

Original EPS (NT$ per share) $ 3.82 $ 3.84 $ 3.83

New EPS Forecast 2016(F) 2017(F) 2018(F)

Original EBIT (NT$ M) $ 14,872,932 $ 15,090,562 $ 15,311

Profit from Growth (NT$ M) $ 147 $ 298 $ 456

Profit from Cost Reduction (NT$ M) $ 629 $ 412 $ 191

Profit from Sales Accretion (NT$ M) $ - $ - $ 1,782

Interest Expense (NT$ M) $ 403 $ 565 $ 791

EBT (NT$ M) $ 15,245 $ 15,236 $ 16,949

Net Profit (NT$ per share) $ 12,547 $ 12,539 $ 13,949

New EPS (NT$ per share) $ 3.17 $ 3.17 $ 3.53


Appendix 12 -

Key financial information of Foxconn in 2014


Income Statement Information (NT$ M)

2014(A) 2013(A)

Current EBIT = $ 189,127

Current Interest Expense = $ 15,007

Current Capital Spending $ 26,414

Current Depreciation & Amortization = $ 70,232

Tax Rate on Income = 24%

Current Revenues = $ 4,213,172

Current Non-cash Working Capital = $ 139,776

Chg. Working Capital = - $ 1,476,960

Cash and Cash Equivalent $ 683,511

Book Value of Debt = $ 1,478,038 $ 1,506,536

Book Value of Equity = $ 984,679 $ 805,925

Market Capital Information

Market price per share = $ 92.50 NT$

& Number of shares outstanding = 15993228 # (張)

& Market Value of Debt = $ 1,478,038 NT$ M

Debt to capital ratio to be used 64% %

Costs of Capital Components

Market Return (1 year) 10.70%

Beta (1 year) 1.21

Risk-free Rate (1 year) 1.18%

Cost of Equity = 12.69%

Cost of Debt = 2.02%

Earnings Inputs

High-growth Phase Growth rate 0.96%

Stable Phase Growth rate 0.96%

Return on Capital

Return on capital in perpetuity 4.75%

1. Cost of equity is estimated by the CAPM in 2014.

2. Cost of debt = average 2 year corporate bond yield in

2014 + corporate risk premium.

3. Growth rate is estimated by t5-year sales CAGR.

4. Return on capital in perpetuity is estimated by the

current ROA minus the GDP growth rate.

BizPro 9th

Appendix 13 -

EBIT forecasts of Foxconn after acquisition

30

2016(F) 2017(F) 2018(F)

EBIT (NT$ M) $ 190,943 $ 192,776 $ 194,627

EBT (NT$ M) $ 175,936 $ 171,766 $ 167,614

Net Profit (NT$ M) $ 133,870 $ 130,697 $ 127,538

Original EPS (NT$ per share) $ 8.37 $ 8.17 $ 7.97

New EPS (NT$ per share) $ 8.19 $ 8.00 $ 7.80

3.82 3.84 3.83

3.17 3.173.53

0.00

1.00

2.00

3.00

4.00

2016(F) 2017(F) 2018(F)

SPIL's EPS Dilution


8.37 8.17 7.978.19 8.00 7.80

4.00

5.00

6.00

7.00

8.00

9.00

2016(F) 2017(F) 2018(F)

Foxconn's EPS Dilution



Economy & Finance

Is SPIL a right choice for FOXCONN to acquire in the packaging industry?