What's new

On the night of March 1, 2022, Tongtech announced to China Mobile Capital and to Tongtech’s Chairman the termination of its plan to issue a fixed-rate private placement plan (intended to raise Rmb0.85bn) and the strategic cooperation memorandum with China Mobile Capital and China Mobile. On the same night, the company announced its plan to issue a new private placement plan of up to 120mn shares, intending to raise Rmb2.2bn from a maximum of 35 specific investors. Tongtech plans to use the proceeds to fund R&D into middleware products of its Tong series and into its network security products.

Comments

New private placement plan issued, likely with larger issuance size and wider coverage. Tongtech decided to withdraw its application for fixed-rate private placement to China Mobile Capital and initiated a new private placement plan through bidding because of the changing capital market and its own actual needs and development plans. The company intends to raise Rmb2.2bn via this new plan, which is much higher than the issuance size of the previous plan and will provide ample funds for its future R&D and market expansion, in our view. Further, the company plans to issue the private placement to a wider range of investors, which is likely to attract more diversified (and especially strategic) investors within the industry. Meanwhile, we believe China Mobile Capital and the company’s Chairman will be among the investors of the new plan.

Existing businesses and market expansion both making steady progress YTD. Tongtech has made steady progress in its basic software and security solutions businesses since the beginning of 2022. In particular, the company was deeply involved in the 2022 Winter Olympics as an intelligent security solutions supplier to provide communication support and emergency communication services. The company plans to use the proceeds raised through the private placement to further ramp up its R&D in emergency and security platforms to meet growing demand in various fields such as public security, which will contribute incremental earnings in our view. In addition, Tongtech will continue its cooperation with key strategic clients such as China Mobile despite the termination of the previous private placement plan and strategic cooperation memorandum signed with China Mobile. We expect the company’s middleware-centered basic software business to maintain rapid growth in 2022, driven by accelerating import substitution across all industries.

Valuation and recommendation

We believe import substitutions for middleware saw intensified market competition in 2H21, leading to price fluctuations and likely further weighing on the company’s earnings in the short term. Therefore, we lower our 2021 and 2022 revenue forecasts by 14% and 8% to Rmb867mn and 1,228mn and introduce our 2023 revenue forecast at Rmb1,633mn. We cut our 2021 and 2022 net profit forecasts by 26% and 11% to Rmb293mn and 480mn and introduce our 2023 net profit forecast at Rmb682mn. We maintain an OUTPERFORM rating and our TP at Rmb39 given valuation switch to 38x 2022e P/E, implying 40% upside. The stock is trading at 27x 2022e P/E.

Risks

Disappointing progress in import substitution; intensifying competition.