Leading PC / Peripheral Retailer

NOTICE : Kim Eng Securities (Thailand) Public Company Limited (KIM ENG) has participated as an underwriter in relation to the initial public offering of IT CITY Public Company Ltd. (the Company). This document was prepared by KIM ENG independently of the Company. In particular, the forecasts, opinions and expectations expressed in this document are entirely those of KIM ENG and are given as part of its normal research activity and not as an underwriter of the share offering or as an agent of the Company, any other syndicate member, or any other person. While all reasonable care has been taken to ensure that the facts stated herein are accurate and that the opinions and expectations contained in this document are fair and reasonable, neither KIM ENG nor the Company has verified the information given in this document. Accordingly, no representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information contained in this document. No one at KIM ENG, the Company or any other person, or any of their respective directors, officers or employees, accepts any liability for any direct or consequential loss arising from any use of this document or its contents or otherwise arising in connection therewith.

• IT City Plc. (IT CITY) has emerged as one of the leaders in IT retailing in Thailand. IT CITY offers one-stop shopping for IT products, personal computers (PCs), peripherals and accessories. IT CITY superstores have become very popular with end-users, who require a variety of IT products at competitive prices as well as prompt and efficient after-sales service.

• From 1999 to 2001, Thailand’s IT market racked up an impressive CAGR of 27%. We are still confident on the sustainable growth of IT market in Thailand largely due to several crucial factors of low computer-usage penetration, economic recovery, governmental support and cheaper computer prices.

• IT CITY will use the proceeds of its rights offering and IPO to expand its number of branches from 10 to 20. This branch expansion will allow the company to gain economies of scale and raise its bargaining power with suppliers.

• This year, we are projecting 32% growth in earnings to Bt42mn. Our forecast, we believe, is conservative, as we assume initial losses from the ten new stores to be opened this year and the possibility that a Second Gulf War would have some impact on nationwide IT spending. In 2004, we expect revenue growth of 32% to Bt2.8bn and earnings growth of 116% yoy to Bt92mn.

• IT CITY’s IPO price of Bt4-5 should be viewed as a package combining the value of its common shares and the free warrants. We value IT CITY’s common shares at Bt2.5 apiece based on our discounted cash flow model and the warrants at Bt2-3 based on Black & Scholes warrant pricing model. As a result, the stock appears already fairly valued at the Bt4-5 IPO subscription price.

Figure 1 : Financial ratios

Source: Company data and Kim Eng estimates

Assuming price for common share of Bt2.5

Company background

IT City Plc. (IT CITY) has emerged as one of the leaders in IT retailing in Thailand. In 1996, the founders, the SVOA Group and the Sahapathanapibul (Saha) Group, opened their first, and biggest, IT CITY superstore in Panthip Plaza – the most popular IT shopping center in Bangkok. Despite its establishment just before the 1997 Asian economic crisis, IT CITY enjoyed strong growth, supported by fast-growing demand for computers and related products by the corporate sector and individuals. Last December the company opened its tenth branch in Bangkok’s Hua Mark district.

IT CITY offers one-stop shopping for IT products, with stores averaging floor areas of about 1,000 square metres. IT CITY superstores have become very popular with end-users, who require a variety of IT products at competitive prices as well as prompt and efficient after-sales service. Sales of IT CITY’s principal products are equally divided into personal computers (PCs), peripherals and accessories.

Figure 2: Existing branches

Source: Company data

Over the last four years, IT CITY has recorded a very impressive performance, with a compounded annual growth rate (CAGR) in revenue of 37% and a 32% CAGR in earnings. This was largely due to aggressive branch expansion, strong demand in Thailand’s fledgling IT market and emerging brand awareness for “IT CITY” retail stores.

Figure 3: Operating performance in 1996-2002E

Source: Company data

Shareholder structure

After the IPO and full warrant conversion SVOA will see its holdings in IT CITY diluted from 54.1% to 43.3%, most of which will be under a 6-month silent period. SVOA is a computer and IT wholesaler and network/software solution provider with more than 20 years experience in the computer and IT industry. The Saha Group, meanwhile, is one of the largest consumer product groups in Thailand with interests in manufacturing and distributing a wide range of consumer items such as clothing, cosmetics, food and electrical appliances.

Figure 4: Change of shareholding structure

Source: Company data

IT CITY started with initial paid-up capital of Bt100mn at Bt1 par (the par value was split from Bt10 to Bt1 last year). Recently, IT CITY raised its registered capital from Bt100mn to Bt310mn. The company is expected to announce a 50% dividend payout from its 2002 net profit to existing shareholders before increasing capital. Thereafter, IT CITY’s existing shareholders will be offered the right to purchase 60mn new shares at Bt1 each. Subscribers to the share offering will also be offered free warrants, with a maturity of 5 years, a 1: 1 conversion ratio and a Bt1 exercise price.

For the second stage of its recapitalisation, IT CITY will issue 40mn new shares in an initial public offering at Bt4-5 each. The IPO is tentatively scheduled for early next month, with subscribers also receiving 40mn free warrants. The new issue of 100mn warrants will trade on the secondary market. As a result, the IPO price is likely to include the intrinsic value of the in-the-money warrants.

Figure 5: Details of IPO

Source: Company data

The company will also issue another 5mn shares under an employee stock option programme (ESOP) after completion of IPO, subject to SEC approval.

IT market in Thailand

Although the global IT market has been hurt by the bursting of the dot.com bubble, Thailand’s IT market has racked up an impressive CAGR of 27% from 1999 to 2001. Industry growth is estimated at a robust 14% in 2002, according to the Association of the Thai Computer Industry (ATCI). The domestic IT market is also supported by the Thaksin government which aims to move Thailand towards a knowledge-based economy. Many projects initiated by the government, such as Internet for Tambons, Schoolnet and e-Procurement, are expected to fuel demand for IT products, particularly in the provinces.

Figure 6: Overall Thai IT market value growth in 1999-2002

Source: ATCI and Company data

IT CITY mainly targets individual clients seeking a variety of IT products such as PCs, peripherals and accessories.

Last year the PC and peripherals market grew an estimated 7% to Bt29bn. IT CITY has posted a CAGR of 37% in sales in 1999-2001, easily outpacing the industry’s average growth rate of 8% during that period. The spectacular growth rate in the PC and peripherals market is due to 1) Thailand’s initial recovery after the 1997 crisis; 2) government efforts to encourage use of computers and other IT products; 3) the country’s low computer usage penetration; and 4) sharp falls in the prices of computers and accessories.

Figure 7: PC and peripheral market and IT CITY performance in 2000-2002

Source: ATCI and Company data

We prefer to measure Thailand’s total IT retail market size by the number of households rather than population because of current industry trends of one PC per household. Based on the 2001 national consensus, there were 16 million households in Thailand. According to the National Information Technology Committee, the PC penetration rate in 2002 was approximately 5.85%, representing 936,000 households. Based on our projections, total PC penetration per household would increase from 5.85% in 2002 to 14.15%, or 2.3 million households, in 2006.

Figure 8: Consumer PC penetration to national households

Source: National Information Technology Committee and Kim Eng estimates

In 2002, Bt28,769mn was spent on PCs and peripherals. Of this, the corporate sector accounted for Bt18,375mn, or 62%. However, we consider only the retail consumer market for IT CITY’s potential client base since corporate clients tend to buy their PC and peripherals directly from suppliers.

Figure 9: IT market penetration to total population

Source: National Information Technology Committee and Kim Eng estimates

If we compare total consumer spending on PC and peripherals in 2002 of Bt10,394mn to the total penetration rate of 936,000 households, each household spent on average Bt11,105 last year. Assuming this rate of spending remains constant, total PC and peripheral sales to the consumer segment would increase to Bt25,542mn by 2006, representing an average compound growth rate of 23.2%.

Future expansion

This year IT CITY plans to open 10 more branches: 4 in Bangkok and 6 in major provinces such as Chiang Mai, Phitsanulok, Khon Kaen, Phuket and Hat Yai. As well as boosting sales, the branch expansion project should improve the company’s economies of scale and give it greater bargaining power with suppliers, leading to higher discounts.

Figure 10: New branches

Source: Company data

The expansion programme will cost IT CITY about Bt100-120mn in 2003, with most of the cost going towards store furnishings, rent and IT systems. In addition the company will need fresh funds of Bt30-40mn for working capital to operate the new branches.

Although IT CITY is debt-free, it will gain various financial advantages from its IPO and SET listing including a drop in its corporate tax rate from 30% to 25%, starting next year.

IT CITY’s future prospects

Last year, IT CITY recorded sales and earnings growth of 27% and 55% respectively. We expect sales and profit growth to slow to 24% and 33% in 2003, largely due to low contributions from new branches. Although there is strong evidence to believe that computer users are switching from small outlets to superstore chains like IT CITY, it will take time to change the purchasing behaviour of some price-sensitive consumers.

Last year, IT CITY expanded its market share of the total PC and peripherals markets from 2.95% to 3.49%. The company’s growth in sales of 27% exceeded the industry’s growth of 9%. This was due to 1) its aggressive branch expansion in both Bangkok and upcountry areas; and 2) narrowing price differentiation between superstores and small outlets.

The major strength of superstores like IT CITY over small outlets or IT retailers is the ease and convenience for customers of a vast, one-stop shopping area for IT products. This allows it to display a huge array of brand-name products from IT market leaders such as ACER, HP, COMPAQ and SONY. Its six years of operations have helped IT CITY become a well-recognised brand in its own right and allowed it to build a reputation for delivering reliable products and services to customers.

Figure 11: IT CITY’s revenue breakdown

Source: Company data and Kim Eng estimates

Another strength of IT CITY’s business is the limited number of direct competitors due to the high working capital requirements. The only major player in the IT superstore market is Data IT. However, IT CITY has first mover advantage, allowing it to open branches in areas of high population density and shopping centres popular with computer users.

Figure 12: Estimated growth of sales revenue

Source: Company data and Kim Eng estimates

We expect IT CITY to report a net profit of Bt32mn in 2002, an increase of 56% yoy. This year, we are projecting 32% growth in earnings to Bt42mn. Our forecast, we believe, is conservative, as we assume initial losses from the ten new stores to be opened this year and the possibility that a Second Gulf War would have some impact on nationwide IT spending. Margins should remain razor thin and we assume the company will choose to begin its five-year reduced corporate income tax rate in 2004 when earnings start to come through instead of its listing date in March 2003.

We expect to see a big jump in IT CITY’s earnings in 2004, as the ten stores opened in 2003 should begin to show better earnings performance and the company’s tax rate is reduced from 30% to 25%. Furthermore, with higher sales volume, IT CITY should be able to negotiate larger discounts with suppliers. We also believe the current negative external factors should begin to ease and economic conditions improve. As a result, we estimate 2004 revenue growth of 32% to Bt2.8bn and earnings growth of 116% yoy to Bt92mn.

Like other retailing companies, IT CITY has to survive on thin margins. Over the four-year period 1999-2002, IT CITY’s gross margins averaged only 11% to 13% and its net margins of 1.4% to 2.0%. For this reason, the company needs to maintain a relatively low gearing ratio and finance new branch expansion through capital raising exercises.

We believe that IT CITY has a good control system in place to manage its working capital. Recently, the company approved a more conservative inventory and receivables accounting policy. Given the rapid change in technology, the company set aside an allowance for outdated inventories by shortening the cut-off period from two years to one year. In addition, the company plans to more closely manage its wholesaling business, which accounts for roughly 20% of sales, in order to limit its cash tied up in accounts receivables. For example, if IT CITY’s provincial branch sells to retailers in neighbouring provinces, the company will not allow accounts receivables to grow faster than accounts payable.

Figure 13: Net operation

Source: Company data and Kim Eng estimates

Valuation

IT CITY’s IPO price of Bt4-5 should be viewed as a package combining the value of its common shares and the free warrants. We value IT CITY’s common shares at Bt2.5 apiece using a discounted cash flow model. Based on this fair value estimate and Black & Scholes warrant pricing model, IT CITY’s warrants should trade around Bt2-3 in the market. As a result, the stock appears already fairly valued at the Bt4-5 IPO subscription price.

After spending Bt100-120mn on branch expansion in 2003, IT CITY should turn free cash flow positive from 2004-2012. We estimate that the company will spend approximately Bt40-80mn per annum over this period on maintaining its IT network, showcases, etc. for its 20 branches. We also factor into our financial model the need to almost double the company’s net working capital to support the growth in sales.

We are applying a 17% discount factor to our DCF model to derive IT CITY’s net present value from its future free cash flow. Given the company’s debt-free position, our discount rate is derived from CAPM with the composition of a 4.5% risk-free, 8% risk premium and 1.0x beta. Meanwhile, we conservatively define this company as a 2% growth business, resulting in Bt223.3mn present value of its terminal value.

We have included 100mn units for warrant conversion in our forecasts. IT CITY has issued warrants to rights and public offering subscribers at a 1:1 ratio. The exercise price is Bt1 per share and IT CITY-W1 can be converted once every 6 months started in 2006. Given its low exercise price, IT CITY-W1 is in the money.

Figure 14: Valuation

Source: Kim Eng estimates

Figure 15: Black & Scholes value of IT CITY’s warrant

Basic assumption :  50% of volatility

5% of risk free

IT CITY's price	IT CITY-W1
2.00	0.91
2.50	1.22
3.00	1.54
3.50	1.86
4.00	2.18
4.50	2.51
5.00	2.84
5.50	3.17
6.00	3.50

Source: Kim Eng estimates

Figure 16: Profit and loss statement

Source: Company data and Kim Eng estimates

Figure 17: Balance sheet statement

Source: Company data and Kim Eng estimates

Figure 18: Financial ratios

Source: Company data and Kim Eng estimates