Bankers Trust Research

Lite-On Electronics: Dependable Power in a New Light - AW 4/99
Bankers Trust Research/BT Alex. Brown Research
Lloyd Ong
April 01, 1999

BT Alex. Brown

ASIA WINDOW (April 1999)
Taiwan - Convertibles

LITE-ON ELECTRONICS
DEPENDABLE POWER IN A NEW LIGHT

BUY 0.5% CB due '04

Lloyd Ong  (852) 2533-8116
           Lloyd.ong@bankerstrust.com

Investment Summary

We initiate coverage of Lite-On Electronics (Lite-On) with a
BUY on the 0.5% CB due '04. The CB is currently trading at a
price of 98 and a YTP of 10.7% (T+573 bps).

We  have a Buy recommendation on the CB because we think  an
expected return of 10.7% offers attractive value relative to
the  company's  strong  credit fundamentals.  For  1998,  we
estimated the debt-to-EBITDA ratio at 2.6 times and  EBITDA-
to-interest  ratio  at  4.7 times. With  sales  and  margins
having  bottomed  out  at the end of  last  year,  we  think
earnings prospects for Lite-On should improve going forward.
As  the company continues to shift and expand its production
in  China, it can reap substantial margin benefit. Margin on
its  China products is estimated to be 10% higher  than  its
operation in Taiwan.

Conversely,  we see limited value in the equity  feature  of
the  CB  due to the high premium of 74.4%. According to  our
conversion  return calculation, we estimate  the  underlying
share would need to achieve a breakeven price of NT$132.5 in
order for the equity option to yield an equivalent return to
the  YTP  of  10.7%  on the put date. With Lite-On's  shares
trading at NT$57.5, the share price would therefore have  to
appreciate by an annual rate of 29% during the life  of  the
CB. As such, we think it would be a hard task for the shares
to  perform  to  such a high valuation level even  with  our
higher  earnings  forecasts  for  the  company.  On  a   P/E
valuation basis, we believe the company should trade between
a range of 18-20 times in the medium term.

Investment Considerations

Positives

- Strong   financial  position.   In   our  view,  Lite-On's
  financial  position  is   strong.   Its  low  costs,  cash
  generative   switching  power  supplies  (SPS)  and  opto-
  electronics   businesses  have   allowed  the  company  to
  maintain  a  consistently  low  leverage,  with  net  debt
  estimated at 0.16 times in 1998.  The debt-to-EBITDA ratio
  is  estimated at 2.6 times in 1998 and should  improve  to
  2.0  times in 1999.   Despite  higher interest costs  from
  increased  short-term bank borrowings, EBITDA-to  interest
  ratio  is likely to improve to 5.3 times in 1999, up  from
  4.7 times in 1998.

- A major player in SPS and opto-electronics industries.  As
  the   world's  10th  largest producer of  switching  power
  supplies  (SPS) and opto-electronics products, we  believe
  Lite-On  is poised to rise up the ranks as new  capacities
  are rapidly coming on-line from its facilities in Dongguan
  and Tianjin, China. SPS and opto-electronics accounted for
  65% and 35% of total revenue for Lite-On in 1998.

- Top-tier customer base. Lite-On has a solid customer list,
  including  market leaders in the PC, computer  peripherals
  and  office automation sectors such as Compaq, IBM,  Dell,
  Packard Bell-NEC, Twinhead, I-Omega and Canon. We estimate
  the  top five customers accounted for more than 85% of its
  total  sales in the power conversion division in 1998.  In
  the   opto  division,  the  company  has  strong  business
  relationships with such major telecommunication players as
  Motorola,  Samsung, Philips, Thomson and Microsoft,  which
  together  accounted for 30% of total opto sales  in  1998.
  The  OEM  markets are significant as they typically  drive
  component demand.

- Global    manufacturing  and  distribution   capabilities.
  Besides  its  onshore production facilities,  Lite-On  has
  established  key manufacturing plants  in  Thailand  (opto
  products);  Malaysia (SPS); UK (SPS); Dongguan (SPS);  and
  Tianjin  (Opto). Its extensive overseas presence has given
  the  company's  competitive advantage through  lower  cost
  structure, which is critical in this low margin and  price
  sensitive  industry. In addition, its global operation has
  enhanced time-to-market and services for its overseas  OEM
  customers.

- Diversified  customer base across various industries.   In
  the  highly competitive SPS and opto  businesses,  Lite-On
  serves   a  diverse  section  of  core  customers  in  the
  computer, telecommunication and office automation markets.
  The  company also provides a wide array of products,  thus
  reducing the risk of product obsolescence. Its revenue and
  earnings stream is thus more stable than its semiconductor
  counterparts.

- Strong  demand  in sub-US$1,000 PCs to drive  SPS  growth.
  Although  increased demand for low-end PCs  will  pressure
  SPS'  pricing  and margins, we believe the impact will  be
  more   than   offset  by  stronger  volume  growth,   thus
  benefiting  major original design manufacturers (ODM) like
  Lite-On.  In our view, the company is well  positioned  to
  gain  further  market  share as it continues  to  ramp  up
  capacity in China. We expect revenue contribution from its
  mainland  operations to hit 60% by 2000, up from 40%  last
  year.

Negatives

- Pricing pressure.  Like all component suppliers in the  PC
  industry,   Lite-On  suffered  from   persistent   pricing
  pressure  in  1998.  The decline in average selling  price
  (ASP),  especially in the SPS business, was attributed  to
  overcapacity  caused by slower than expected PC growth  in
  the  last  quarter of 1998.  We estimate the ASP of  power
  supplies  has  declined  by  20% in 1998.   Corresponding,
  Lite-On's  operating  margin  contracted to 7.7% in  1998,
  down from 12% in 1997.  We expect further pricing pressure
  in  the near term as consolidation takes hold on the power
  supply industry.

- Low financial transparency. Lite-On Group reports detailed
  consolidated financials only once a year.  On a  quarterly
  basis, earnings from its unlisted overseas  operations are
  reported   under  the company's unconsolidated  investment
  income  line.   With  increasing  contributions  from  its
  mainland operations - Lite-On (Tianjin) and Dongguan  Lite
  Power Plant, analyzing the company's results are difficult
  and   fraught  with  potential  earnings  surprises  going
  forward. For 1998, we estimate investment income accounted
  for a high 40% of unconsolidated net profit.

- Strong   competition.   With   the  desktop  and  notebook
  businesses as  its main markets, Lite-On faces significant
  direct competition, especially from Astec BSR (Hong  Kong)
  and  Delta Electronics (Taiwan), the world's 2nd  and  4th
  largest  producers of SPS. These companies occupy  similar
  niches  in the  market and are financially much  stronger,
  supplying more than 80% of their output to PC OEMs.  While
  competition  is  endemic to the PC component business,  we
  are   optimistic  that  Lite-On,  with  its  strong   R&D,
  competitive    cost    structure   and   strong   customer
  relationships,  will  continue  to strengthen  its  market
  position in both the SPS and opto-electronics businesses.

Background

Lite-On Electronics is among the world top ten suppliers  of
opto-electronics  devices and switching power  supplies.  It
was founded in 1975 and was the first electronics company to
list  on  the Taiwan Stock Exchange. The company is part  of
the Lite-On Group, a diversified electronics conglomerate in
Taiwan that also includes publicly listed companies such  as
Lite-On  Technology,  Silitek Corp.  and  Dyna  Image  Corp.
Although Raymond Soong and family only have a direct  equity
holding  of 4% in the company, their actual ownership  stake
is  believed  to  be much higher through the  complex  cross
shareholding   structure  within  the  group's  wholly-owned
oversea subsidiaries and sister companies.

In  the opto-electronics division, the company has developed
a   wide  range  of  infra-red  LED  products  that  include
photodiodes,  lamps,  photocouplers,  receivers  and   clock
display.  Major  competitors are mainly small  divisions  of
leading electronics players like Sharp, Hewlett-Packard  and
Sony. In the power conversion division, the company provides
a   full   range  of  SPS  for  application   in   the   PC,
telecommunication and office automation devices.

Consolidation is the theme in the power supply industry

More than a dozen acquisitions occurred in the past year and
we  think  the  trend is likely to intensify in  the  coming
years.  As  pressure on pricing escalates,  especially  from
large  OEM  customers, consolidation and strategic alliances
are  likely  to be forged between power supply companies  to
achieve  the critical economies of scale and larger customer
base   required  to  survive  in  this  fiercely   contested
industry.  Major  players will have the advantage  of  high-
volume  component  purchasing to reduce the  cost  of  power
supplies where raw materials typically take up about 75%  of
total  production  cost. The most notable acquisitions  that
have  occurred  include  Computer Products'  acquisition  of
Zytec  in  the  US;  Astec's purchase of Northern  Telecom's
Advanced  Power  Systems; Siebe Power  Controls  (parent  of
Lambda Electronics) takeover of Electronic Measurement;  and
Celestica   Power  Systems'  acquisition  of  Ascent   Power
Technologies.  As  the  industry still  has  more  than  300
companies  globally, of which more than 100 are  in  Taiwan,
there  will  be plenty of acquisition opportunities  in  the
market,  in our view. Many of the smaller and weaker players
will  likely  be  acquired or go under in  coming  years  if
prices remain soft.

In Asia, major power supply makers however have been ramping
up  capacities at a furious pace despite falling prices. For
1998  and  beyond, we expect Taiwan to maintain its position
as  the  world's largest supplier of SPS with  an  estimated
market  share  of more than 60%. The two major suppliers  in
the  country, Lite-On and Delta Electronics, in our opinion,
are well positioned to capitalize on the consolidation trend
to  strengthen  its market share further in  view  of  their
healthy  financial positions, low cost structures, economies
of   scale,   and   strong  distribution   and   procurement
capabilities.

Conversion Return Scenario

Our  conversion return scenario table illustrates  that  the
yield obtain from CB conversion is highly sensitivity to the
time  required in achieving targeted share prices. Based  on
the  yield (bold figures) calculated in the table, investors
would  gain  an  attractive return  over  the  YTP,  if  the
underlying  share  reaches  the  targeted  prices   at   the
stipulated dates.

Based  on  our return scenario, we have calculated that  the
breakeven  share price on the put date for Lite-On's  CB  is
NT$132.5. At this price, the securities will earn  a  return
equivalent  to the YTP of 10.7%. With a current share  price
at  NT$57.5,  this  means  that the  equity  would  have  to
appreciate by an average of 29% per annum until the put date
(3.25  years)  just to breakeven on the YTP.  If  the  share
price  trades  above the breakeven price  on  put  date,  CB
holders  would  be better off converting the  securities  by
earning the additional yield over the YTP of 10.7%, as shown
in  shaded  bold. Conversely, if the underlying share  price
trades  below  the  breakeven price, then  our  calculations
indicate that CB holders should put the bonds.

Financial Analysis

Lite-On's  financial position is strong. Its low-cost,  cash
generative SPS and opto-electronics businesses have  allowed
the  company  to  maintain  a low leverage,  with  net  debt
estimated at 0.16 times in 1998. The debt-to-EBITDA ratio is
estimated  at  2.6 times in 1998 and should improve  to  2.0
times  in  1999.  Due  to higher interest  expense  incurred
resulting  from  higher bank borrowings in 1998,  EBITDA-to-
gross  interest expense ratio is expected to fall from  10.2
times  in 1997 to 4.7 times in 1998, which is still high  in
view  of the lower business volatility. We expect EBITDA  to
strengthen  in the next two years as the company  ramped  up
its  production  in  the mainland to  cut  costs  and  boost
operating  margin. We estimate the interest  coverage  ratio
could  improve to 6.3 times and 6.6 times in 1999 and  2000,
respectively.

Despite suffering from a decline in revenue and earnings  in
1998  on  a  consolidated basis, the credit fundamentals  of
Lite-On remain attractive. After sales growth peaked in  the
3rd quarter of last year, the company experienced continuous
price  pressure for its SPS products and LED (light emitting
diode)  chips.  As  a  result, the  company  was  unable  to
maintain its growth momentum into the 4th quarter, which led
to  a  14.8%  q-o-q  sequential decline in  revenue  and  an
overall negative growth of 11.4% at group level. We estimate
operating margin to fall from 12.0% in 1997 to 7.7% in  1998
while the pre-tax margin to contract from 14.0% to 12.5% due
mainly  to foreign exchange gain. Although we expect pricing
pressure  to  continue in the medium term, we think  further
compression  in  its  operating margin is  unlikely  as  the
company  continues to ramp up production capacity  from  its
efficient  mainland  plants  and  increase  its  value-added
production to help reduce operating costs. We estimate Lite-
On's mainland plants' gross margin to be at least 10% higher
than its counterpart in Taiwan.

Management  is  expected to spend NT$1.0  billion  in  1999,
mostly  for  capacity  expansion  in  mainland  plants   and
improvements  to other plants. Funding is expected  to  come
from  internal reserves for now. Even if the company decides
to  use  debt  to  fund the expansion, we do not  anticipate
substantial  incremental  in  leverage  in  1999,  which  is
estimated at 0.46 times

Earnings Outlook

After  a  sluggish year of sales performance  attributed  to
continuous  price pressure in 1998, we believe Lite-On  will
regain its earnings growth momentum over the next few  years
in  line  with improving fundamentals of the PC markets  and
stronger   demand   in  the  communications   and   consumer
electronics products. We anticipate the company will benefit
strongly from an increase in foreign orders, particularly in
the ODM segment and the expanding mainland market, where  it
has  been  investing  heavily in the  last  two  years.  The
company  expects  revenue from its  mainland  operations  to
increase  from  40% in 1998 to more than  60%  by  2000.  We
estimate  sales  to grow at 18% and 20% in  1999  and  2000,
respectively.

With  increased capacity and the production of higher value-
added products, Lite-On should be able to boost revenue  and
earnings  in  the  next  few  years.  Growth  in  the  opto-
electronics segment should be fueled by solid demand in  the
communications  and  digital  consumer  electronics  markets
while  the  SPS  business  will continue  to  be  driven  by
intrinsic growth in PC and PC server markets.

Recommendation

Being  a  major  player  in  the  SPS  and  opto-electronics
industry,  we  believe Lite-On is well  positioned  to  gain
further market share as the industry undergoes consolidation
in  the  near  future.  Even though  the  underlying  equity
feature  has very little value, in our view, we recommend  a
BUY on the 0.5% CB due '04 in view of the attractive YTP  of
10.7%  relative  to the company's sound financial  position,
strong business fundamentals and improving earnings outlook.


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