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On May 11, 2022, LinControl Automotive Electronics (LinControl) released a plan to acquire Vitesco Technologies GmbH (VT GmbH), and the oil atomizer-related intellectual property rights and production lines of VT GmbH’s sub-subsidiary in China, Vitesco Automotive.

Comments

LinControl, a leading EMS firm in China, is expanding its presence in the oil atomizer market through acquisition. According to the firm’s corporate filing, LinControl would acquire passenger vehicle (PV) and light-duty truck (LDT) related intellectual property rights, core technologies, and databases from VT GmbH and related parties for Rmb23.4mn. It would also purchase an oil atomizer assembly line that consists of three sub-assembly stations from Vitesco Automotive, a sub-subsidiary of VT GmbH in China, for Rmb5.88mn. In addition to the above assets, LinControl is planning to keep acquiring other oil atomizer, orifice plate and experimental equipment related assets and intellectual property rights from VT GmbH.

Negotiations between the two companies are underway. LinControl has gained a leading position in the engine management system (EMS) market for N1-class vehicles, and it has also seized market share in the crossover PV market. The use of its products is increasing rapidly in saloons, sport utility vehicles (SUVs) and multi-purpose vehicles (MPVs) that have gasoline direct injection (GDI) engines. The firm was previously reliant on oil atomizers produced by other companies. In 2020, the value of oil atomizers purchased from Continental AG accounted for 91.83% of total value of this product purchased by LinControl. We think that the firm will likely produce oil atomizers and reduce its reliance on a single supplier, through purchasing intellectual property rights and production lines. This can also make the firm more flexible in expanding its presence in new markets, and help it maintain auto part supply and increase production volume.

LinControl obtains Continental AG's oil atomizer technologies through purchasing intellectual property rights. VT GmbH was once a powertrain business unit of Continental AG. VT GmbH and sub-subsidiary Vitesco Automotive are world-leading developers and manufacturers of auto powertrains and key components. Auto EMSs are the signature product of LinControl. Its EMS revenue increased at a CAGR of 68.9% over 2018-2020, and accounted for about 90% of total revenue for three consecutive years. Oil atomizers are the most important actuators for EMSs, in our view. We think that LinControl can obtain Continental AG's oil atomizer technologies through purchasing core component technologies.

We expect LinControl to reduce the cost of components of electronic fuel injection engines after acquiring production lines. Gross margin (GM) of oil atomizers is high at around 50%. Oil atomizers and other components of electronic fuel injection engines account for 75-78% of the total cost of components at LinControl. The cost of components continues to increase, as EMSs have become increasingly complicated due to the rollout of worldwide light-duty test cycle (WLTC) working condition standard and other industry-level standards. In our opinion, the move to acquire upstream production lines can help the firm reduce the cost of purchasing components, reduce R&D investment, and ease the pressure of equity incentive amortization. We expect the firm to increase GM and mitigate supply chain risks over the long run, given economies of scale in EPSs and components.

Financials and valuation

We maintain our EPS forecasts of Rmb3.85 for 2022 and Rmb6.77 for 2023. The stock is trading at 28.1x 2022e P/E and 16.0x 2023E P/E. We maintain an OUTPERFORM rating and our target price of Rmb130. Our TP implies 33.7x 2022e P/E and 19.2x 2023 P/E, offering 20.0% upside.

Risks

Overly concentrated customer structure; accelerated replacement of gasoline EMS amid trend toward electric vehicles; declining operating cash flow; growing inventories; issues with chip procurement; impairments of accounts receivable.