- Moving on after embroiled in a patent infringement lawsuit
- Positioning itself to win in the era of disruptive technologies, such as 5G and IoT
- New technology requires more complex tests, leading to higher demand for test sockets
- To benefit from increasing demand for semiconductor chips in China
- Manufacturing partnership with Huawei to make further inroads into China markets
- Explosive growth heading towards FY2022 and beyond.
JF Technology Berhad (KLSE:0146) is an original design manufacturer of test sockets. Their products are used to test and screen microchips for major companies in the mobile and automotive industries. Their clients include BMW, Samsung, Canon, Ford and Dell. JF Tech is now one of the most aggressive intellectual property (IP) owners in Malaysia for the semi-conductor test socket industry. They now have 27 granted patents and 35 pending patents.
What is a Test Socket?
Semiconductors needs to be tested during the assembly and packaging process. An integrated circuit (IC) is used in the final test, which connects the semiconductor device and the tester. Test sockets serves as the interface between the test handler and the semiconductor device to be tested.
Test sockets are a low-volume, high-value business. This is because a test socket has to be designed very precisely to meet customer demands. A test socket must also be highly durable. They must withstand boiling hot temperatures and repeatedly use.
Usually, a client will order three or four sockets just to test a new chip design. If the client decides to use this chip design, the client will use the same test sockets to test its chips.
Moving On After Patent Infringement Lawsuit
On June 2014, JF Tech’s competitor Johnstech filed a compliant in the US District Court of the Northern District of California against JF Tech alleging the infringement of US Patent No 7,059,866 entitled ‘Integrated Circuit Test Contact to Test Apparatus.’
https://www.theedgemarkets.com/article/us-court-dismisses-jf-techs-appeal-patent-infringement-case
In 2018 the Court ruled against the favour of JF Tech and as a result of this lawsuit, JF Tech incurred a total cost of RM16.9million for this lawsuit over the 4 years.
However, following the provision for damages made in FY2018 and 2019, JF Tech now has a clean balance sheet again. This is shown in their FY2019 results when EPS grew 800% due to absence of legal fees and other provisions.
There is silver lining from this episode. Over the past 5 years, JF Tech has developed new products such as Eta and EZ to replace their disputed Zigma. JF Tech has also continued to submit patent applications of new product developments. They now have 27 patents and another 35 pending approval.
Positioning Itself to Win in 5G and IOT
JF Tech is currently riding on the boom in radio frequency (RF) technology. Devices use RF to send signals wirelessly. In FY2020, this segment grew by 98% and comprises 48% of JF Tech’s new projects. Today, 37% of JF Tech’s sockets are used for RF applications compared to 18% in FY2017.
This proves that JF Tech is moving in the right direction and is slated to benefit from the upcoming adoption of 5G network devices.
As the world moves from 4G to 5G, the value of radio-frequency(RF) content in smartphones will almost double, according to U.S. chipmaker Skyworks Solutions. To use 5G, every 5G-enabled device will need many more RF parts such as antennas and chips.
Boosted by 5G, chip industry revenue will rise 5.9% to $448 billion in 2020, according to IHS Markit. This will be a rebound for chip sales, which suffered a 12.8% decline in 2019 due to an oversupply of certain components.
New Technology to Drive Longer Test Times, Leading to Higher Demand for Test Sockets
Advancement in 5G, automotive and memory & data storage will drive longer test times. It was only in 2017 when Taiwan Semiconductor Manufacturing Company (TSMC) moved into mass production of 10nm chips, now we are already looking at 7/5nm chips and TSMC is expected to be building 3nm chips by 2022.
As technology nodes get smaller, it means that there will be more transistors packed into a chip. As such, it will take a longer to time to test per chip. Systems and devices also need to be rigorously tested to higher standards through system level tests. This is to ensure that they do not fail in various safety-critical markets such as automotive (driverless vehicles).
As the number of potential defects increase, more complex tests have to be performed and longer test times are required. As such, chipmakers will require more test sockets from JF Tech to cater to the longer test times.
To benefit from Increasing Demand for Semiconductor Chips in China
“Made in China 2025” was launched in 2015. The initiative is more of a response to the weakness of China manufacturing capabilities relative to global leaders. It aims to transform China into a manufacturing superpower with 10 priority sectors which include IT, aerospace technology, electric vehicles etc, etc.
In a world in which technology and innovation have become highly globalized, China has sought “self-sufficiency” in core technologies across a range of prioritized industries.
As such, China wants to make its own chips. To succeed, it must have access to important manufacturing components, such as test sockets. Although China is one of the world’s biggest electronics manufacturers, it now buys most of its chips from other countries. China targets to produce 70% of the ICS consumed by 2025. This is a significant increase from the current 19%.
One of the key initiatives in China that is leading to higher levels of semiconductor consumption is 5G. China expects to install a million base stations for 5G in 2020. In addition to having the 5G infrastructure, there are also 5G phones. Based on the current production capacity, Chinese companies probably will produce 65-70% of global demand of 5G phones.
JF Tech will benefit from China’s increasing demand for chips. China is their largest revenue contributor at 34% (China 34%, Malaysia 25%, USA 11%).
Manufacturing partnership with Huawei
On 26 October, JF Tech announced that its wholly-owned unit JF International Sdn Bhd is partnering with Huawei’s venture capital arm Hubble Technology Investment Co Ltd (HTI) to set up a plant for the manufacture and supply of high-performance test contactors in China.
This collaboration is positive news for JF Tech on many fronts.
1) Benefit from “Made in China 2025”. By having a plant in China, it will allow better access into the China market. This will lead to reduced lead times and enhancing supply chain efficiency. JF Tech has also stated that their proposed manufacturing plant in Kunshan, Jiangsu Province is near to their major customers. Products from the plant will cater solely for Huawei in the first two years. It may start supplying to other customers thereafter.
2) JF Tech will supply a minimum of 600 test sockets in the first year before doubling to 1200 in the second year. If we assume USD3000 per test socket, the new plant could rake in USD5.4mil sales in the first 2 years.
3) There were reports that said Huawei is planning to manufacture their own chips. This is in view of the trade war restrictions where companies like TSMC will stop supplying chips to them.
https://www.ft.com/content/84eb666e-0af3-48eb-8b60-3f53b19435cb
If that is true, JF Tech will be able to enjoy first movers advantage by becoming Huawei’s strategic partner in the supply chain.
Explosive Growth Heading into FY2022 and Beyond
This is my forecast for JF Tech’s topline and bottomline up to FY2022.
JF Tech reported a strong start into FY2021 with quarterly revenue and net profit growth at 42% and 121.5% respectively. Net profit margin is more than 40% which is very good. I expect this to continue for the rest of the year.
I also forecasted that JF Tech will have very high revenue growth in FY2022 due to the reasons below;
1) Kunshan plant targets to commence in 3Q2021. This plant will produce a minimum of 600 test sockets for the first year and 1200 in the second year.
2) Completion of the expansion of its existing plant in Kota Damansara, Selangor in March 2022. This will nearly double the built up area to 90,000 sq ft from 46,000 sq ft.
3) Revenue contribution from its newly established subsidiary JF TestSense Sdn Bhd. This company provides test interface solutions. JF Tech aims to provide total turnkey solutions for their customers and not just test sockets. This move brings the company closer to one of their competitors Cohu Inc (NASDAQ:COHU).
Risks
1) Escalation of Geopolitical Events
The ongoing trade war has disrupted the semiconductor industry. With a new US Presidential administration, there is still a chance that the US-China supply chain will decouple.
Any negative outcomes of the Huawei ban will have detrimental effect on JF Tech.
2) Protraction of the Covid-19 pandemic
We are starting to see city lockdowns worldwide to contain the spread of the pandemic. If Malaysia and China’s Covid-19 situation worsens, JF Tech production could be affected.
3) Bonus Issue with Warrants
On Oct 2020 JF Tech announced a bonus issue of 3 shares and 2 free warrants for every 1 share.
https://www.theedgemarkets.com/article/jf-technology-proposes-bonus-issue-free-warrants
As of now we are still waiting for updates on the exercise price of the warrants. If the exercise price are lower than the share price post bonus issue, there is a higher chance that the warrants will be exercised. This would lead to further dilution of shares.
The shareholders will benefit if the money raised is used to fund their growing business in China. This way, the growth in earnings per share might be able to offset the increased share count.
4) Slowdown in Growth
JF Technology is currently trading at very high valuations. This is due to the expected high growth of the company. Any deviation in this thesis would meant that JF Tech’s profit growth will not be able to catch up to its valuations. This will be negative and will cause a re-rate of the share price.
Conclusion
The outlook for JF Technology is positive considering the growth plans that they have in place. Having Huawei as a strategic partner bodes well for the company as they will be able to gain access into the China market. The increasing demand for semiconductor chips is also positive for their business.
I expect that JF Technology will be able to experience explosive growth in the coming years as their investments start to bear fruit. However, the valuations are currently very high and any slowdown in their growth will be affect its share price negatively.
Escalation of geopolitical events, protraction of the Covid-19 pandemic and the issuance of the warrants are the key risks to our view.
This is a company with high good growth prospects. Due to the high valuations, I might only consider adding on dips. The bonus issue with warrants also makes things a bit more complicated as I’m not sure how to deal with warrants.
Cheers