PepperBall  -  a potential game changer.  As the  pepper spray  currentlyhas  limitations  -  being  a  short-range  weapon  -  we  expect  IPS'PepperBall  product,  which  has  been  trialed  and  tested  by  the  US Government  to  be  the  key  enforcer  for  riots  and  replace  the  pepper spray  going  forward.  We  estimate  that  the  size  of  a  deal  just  for  the PepperBall  launchers could translate to  a minimal  USD30m and above per country for IPS. In addition, the recurring revenue generated from the constant supply  of  PepperBalls,  which  could  be  used  for  training,  may add an estimated USD5m onwards per year per country to IPS' recurring revenue  stream. We  expect  PepperBall  to  significantly contribute  to and lift group earnings, with the full impact expected from FY16 onwards. 

Healthy orderbook of SGD24.5m.  As of 17 Oct, its  orderbook  was at arobust  SGD24.5m  -  with 27%  from security solutions and 73% from  its recurring  maintenance  and  leasing  business.  The  size  of  its  current orderbook  alone  is  almost  double  its  FY14  revenue.  We  also  expect orders  to surge  further  in FY15 with potential contract wins from SMRT(MRT SP, NEUTRAL, TP: SGD1.50), as well as from its new products. 

BUY with  a  TP of SGD1.26  (7x  FY16F P/E).  As the  homeland security industry has high barriers of entry due to the high security clearance and proven track record  required  for companies,  IPS  is  in a unique positionable to benefit from the  increase in government defense budgets across the region due to political instability and rising national securit y concerns. With  high  2-year  (FY14-16)  expected  revenue  and  NPAT  CAGRs  of valuation  is  based on  a  50%  discount  to its local  peer  average of  14x FY15F P/E -which puts our TP at SGD1.26, implying a 7x FY16F P/E. 

Key  Risks:  future  earnings  depend  on  the  PepperBall  products; exposure to FX fluctuation. For more risks, see page 8. 

Investment Merits
PepperBall  -  the next big thing.  Securing the PepperBall authorised distributorship within  Vietnam,  Indonesia,  Malaysia  and  Cambodia  back  in  July  was  a  great  leap forward for  IPS  and might potentially be a major  game changer  that could elevate its business to a whole new level. With these authorised distributorships, we understand from its  management that no other company  can legally  produce or sell  PepperBallrelated  products  unless  they  have  obtained  permission   to  do  so  from  PepperBallTechnologies,  the  producer.  As  the  pepper  spray  currently  has  limitations  -  it  is a short-range weapon that could expose a law enforcer to assault as well as potentially backfire  when  there  is  a  strong  wind  blowing  against  the  direction  in  which  it  is sprayed, which could injure the user  -  we believe the  PepperBall, which has been tested  by  the  US  Government,  could  be  a  key  enforcer  of  riots  as  well  as  a replacement of the pepper spray going forward.

Potentially  massive size of PepperBall deals. We estimated that the size of a deal just for  the  PepperBall  launchers can be valued at  USD30m and above per country depending  on  demand.  In  addition,  the  recurring  revenue  generated  from  the constant  supply  of  PepperBalls,  which  could  be  used  for  training,  may  add  an estimated USD5m onwards per year  per country  to IPS'  recurring revenue stream  -which is significant.

 

Bringing IPS earnings to a whole new level.  As some Asian countries are going through political instability and riots, we expect IPS to conservatively secure USD50mworth of PepperBall equipment deals in FY15, with delivery to span over 2-3 years. In addition,  we  expect  the  company  to  supply  at  least  USD5m  per  year  worth  of PepperBalls in these two years, which would be easily attainable if it does manage to meet  our  target  above.  This  could  lift  IPS'  revenue  and  earnings  significantly  from FY15. However,  they  will only recognize revenue when the goods are delivered to their clients, hence the full impact will only be realized from FY16 onwards.

Co-manufacturing is  a distinct possibility.  Due to IPS'  strong relationship with itssuppliers, there is a great  possibility and potential for the company  to enter into comanufacturing agreements with major suppliers. For example, for PepperBall, it mighteven enter into a  JV  with  a partner to co-manufacture the product,  which could bulk up its recurring revenue, greatly lower costs and widen margins.

Low  inventory  and  credit  risks.  According  to  IPS'  business  model,  it  orders supplies only when it  receives  confirmed orders from  clients. In most circumstances,IPS requires a  50% initial down payment  to be made before it orders the products from its suppliers. As such, there is  hardly any inventory risk. In addition, most of its clients are government agencies or the middle-men  parties  representing government agencies. This implies that the risk of its clients defaulting would be minimal.

Healthy  orderbook  in  place.  As  of  17  Oct  2014,  IPS  has  a  strong  orderbook  of SGD24.5m  with  27%  of  it  from  security  solutions  and  73%  from  its  recurring maintenance and leasing business. We expect its orderbook to grow significantly  in FY15 with potential contract wins from SMRT as well as from   PepperBall  and new equipment sales.

 

High barriers of entry. In order to enter into the homeland security business and for governments  of  other  countries  to  consider  such  companies  as  a  worthy  supplier, players  need  to  have  a  proven  track  record  as  well  as  a  high  level  of  security clearance  which  would  be  extremely  difficult  to  obtain.  In  Singapore,  through  our research, we found out that only companies like Singapore Technology Engineering's (STE SP, BUY, TP: SGD4.66)  subsidiary, ST Kinetics,  and Starburst  Holdings  have the same international security level clearance as IPS. In addition, with distribution deals already tied up with its suppliers which are supplying top-tier equipment for the same  league  of  products,  it  would  be  tough  for  new  entrants  to  enter  into partnerships for suppliers to offer similar or better items.  

Close  relationships  with  suppliers  and  dealers.  IPS  has  longstanding relationships  with  reputable  suppliers  that  alow  it  to  keep  abreast  with  new technology, product  developments and market trends. A great example would be the parent  of  PepperBall  Technologies,  Wattre  Corp,  which  gave  IPS:  i)  the  sole distribution rights for South-East Asia for its PepperBall  products, and ii)  right of  first refusal  for  any  new  products  the  former  might  have.  Its  close  relationships  withdealers  have  led  to  its  regional  revenue  making  up  over  40%  of  total  revenue  in FY11-13 and 1H14. 

Distributes  a wide range of premium security products.  IPS  has been  a leading provider of security products and integrated security solutions since  2000, and offers over  100  types  of  security  products  from  premium  brands  such  as  Leidos, HyperSpike (Figure 6) and Mobotix. The company is still expanding its product range - which could grow in the future.

Sole  distribution  agreements  for  most  of  its  products.  IPS  has  the  sole distribution agreement in Asia for most of its products and brands, except  Mobotix. As the products it carries mostly belong to the top and premium ranges, this gives the company  a  key  advantage  over  any  existing  competitors  or  new  ones  that  are planning to enter  the market.  With such a first-mover advantage,  new players would not  be  able  to  sell  products  that  it  has  rights  over.  In  addition,  the  distribution agreements are on an automated 1-year forward rolling basis until one party cancels out or puts a stop to the agreement for a valid reason, eg  not meeting the terms of the  distribution  agreement.  As  such,  IPS  would  be  able  to  maintain  these  sole distribution agreements for a long period going forward.

Political  instability  likely  to  spur  spending  on  defence.  With  increased  political instability around the region as well as disputes among certain  countries disrupting peace,  government  agencies  and  bodies  as  well  as  commercial  entities  have increased  investments  in  security  infrastructure.  In  addition,  budget  defence allocations  for countries in the region  have been increasing annually  and the trend looks likely to continue.

Valuation   Initiating coverage with a BUY call and a SGD1.26 TP
We  initiate  coverage  on  IPS  with  a  BUY  recommendation  and  a  TP  of  SGD1.26, based on a 7x 16F P/E. 

We  forecast  recurring  net  profit  after  tax  (NPAT)  to  soar  at  a  c.161%  CAGR  to SGD14.4m in FY16F from SGD2.1m in FY14. Its  US-based  listed  peers  are trading at  an  average  of  25.1x  FY15F  P/E  while  its  local  listed  peers  are  trading  at  an average of 14x FY15F P/E.  Due to the relatively smaller scale  of the company when compared  with  its  local  peers,  liquidity  of  the  company  as  well  potential  lumpy earnings recognition, we decide to ascribe a significant 50% discount to its local peer average to arrive at our 7x  FY16F P/E.  Despite such a huge discount to its local and listed  peers,  our  TP  of  SGD1.26  represents  a  potential  upside of  c.86.7%  from  its current trading price.

 

Source: OSK-DMG