9 July 2002
CSA Holdings
Recommendation: Buy
Price: S$1.77

Margin Catalyst In Sight; Ready For Re-Rating

Strategic shift to outsourcing services. After the strategic decision to move away from hardware distribution 3 years ago, CSA has grown its outsourcing services team from nil to 150 outsourcing specialists. This is now yielding results with recent FY3/02 outsourcing revenue jumping 112% yoy. From zero contribution 3 years ago, outsourcing revenue has leapt to S$30m p.a. The best part about this revenue is its recurring nature. Gross margins are also 2-3x more than hardware.

The catalyst for the change came from the acquisition by CSC. CSA has been building up its outsourcing capabilities to support CSC's global customers in Asia. As a result, CSA is now able to service major MNC customers such as DuPont, Nortel and TRW in Thailand, Malaysia, Singapore, Hong Kong and China. This is only the beginning, as it has a captive market of another 80+ CSC global customers yet to transfer their Asian IT needs to CSA. Apart from outsourcing, CSA also enjoys recurring revenue from support and maintenance services. We expect this revenue stream to grow steadily to S$64m in the next FY.

Long track record and entrenched customer relationships. IT service providers build their business on one-to-one relationships, where track records and trust matter. Customers only want the most reputable service providers. This is the biggest barrier to entry in this industry. CSA has more than 3 decades of experience, reflected in its track record of successful IT projects and enviable list of customers (3) . This has allowed revenue to grow at 21% CAGR from 1990 to S$624m presently. The company will next capitalise on customer relationships and move into more services-based revenue, with higher value-add and margins.

Cheapest in the sector. At 5x EV/EBITDA, the company is the cheapest in our IT services sector. Our EBITDA figure excludes a one-off S$4m provision for a directors' incentive scheme introduced in 1999 after CSC's takeover. We see no reason for the valuation discount as it is a market leader in the region. Gartner ranks CSA one of the top 5 largest IT services companies in Singapore and Malaysia. In fact, we look forward to a market re-rating after the company completes its transformation into a pure IT service provider and benefits from a recovery in IT spending.

We rate CSA a BUY, with a price target of S$2.50 (16x PE FY03 & 7x EV/EBITDA). This values the stock at a slight premium to the industry's 12x PE FY03 (ex-Datacraft) but still a discount to the latter's 9x EV/EBITDA. The company is a value buy in our sector.