Krono: Eyes On China

Krono is involved in Enterprise Data Management (EDM) business providing hardware & software solutions to enterprises for data storage & protection as well as EDM managed services.

Before this, Krono has a small presence in China through a 16.67%-owned Quantum China Ltd (QCL). Now it has proposed to acquire the remaining 83.33% of QCL for RM150mil.

Half of the amount will be paid by cash (RM75mil) and the other half will be paid by issuing 110.3mil new Krono shares at 68sen each.

This is the main reason Krono carried out private placement recently by issuing 104.67mil new shares at 66.23sen each to raise RM69.3mil.

So, a total of 215mil new Krono shares are to be issued to fund this acquisition. 

Should existing shareholders of Krono be happy or worry?

Krono has total 523mil ordinary shares before the latest private placement and proposed acquisition. The extra 215 new shares represents 41% dilution.

QCL is a relatively young company incorporated on 24 May 2018. The company is run by two Singaporeans who hold 83.33% of its shares.

Krono acquired the remaining 16.67% shares of QCL in Nov 2018 and QCL has been an associate company of Krono since then.

In its latest financial year ended Jan21 (total 13 months), QCL's net profit was just USD 1.5mil (~RM6mil) from a revenue of USD 16.5mil with a PAT margin of 9.2%.

Paying RM150mil to acquire 83.3% of a company that earns RM6mil a year, is it worth the money paid?

The acquisition comes with net profit warranty of USD2.0mil (~RM8mil) for FYE Jan22 and USD2.5mil (~RM10mil) for FYE Jan23.

In its FY19 before being affected by the pandemic, Krono's net profit was RM18.5mil.

If QCL is able to achieve the profit warranty of RM8mil in FY22, it will be extra RM6.7mil (extra 83.3% shares) to Krono's bottom line.

Thus, the increase in net profit will be 36% from FY19, if Krono existing business matches FY19's net profit in FY22.

If we compare this 36% increase in net profit with the 41% dilution of earning, it looks rather "fair" to Krono's shareholders.

Nevertheless, I think investors or shareholders should look at the potential of QCL in the future.

QCL has been growing fast in less than 3 years since it's incorporated. Its recent audited results are:

FY18 (7 months): Revenue USD 4.3mil, PAT USD 0.003mil

FY19 (12 months): Revenue USD 11.6mil, PAT USD 0.39mil 

FY20 (13 months): Revenue USD 16.4mil, PAT USD 1.5mil (+285%)

If this trend continues, it's very possible that it can fulfill its profit warranty in the next 2 years.

Anyway, if the profit warranty is not fulfilled, the vendor will not top up with cash like most acquisition cases with a profit guarantee. 

The payment of this acquisition will be paid in 3 tranches. The first tranche will be paid on completion date of acquisition while the next 2 tranches will be paid after the audited financial results of FY22 & FY23 are released.

In case the profit warranty is not achieved, the amount of payment will be adjusted downwards. This means that the profit warranty is not "guaranteed" to appear in Krono's bottom line in FY22 & FY23.

China is a huge market with lots of possibilities, so I think the decision to own QCL fully is a good move by Krono's management.

According to market research, EDM industry in China is expected to grow rapidly.

Year 2018: USD 26.3 bil (actual)

Year 2020: USD 40.2 bil (actual)

Year 2021: USD 51.9 bil (forecast)

Year 2023: USD 87.5 bil (forecast) 

With a CAGR of 30% from 2020 to 2023, there seems to be plenty of opportunity for Krono to tap into China EDM market through QCL.

In November last year, Krono announced that it has been awarded exabyte size cloud hyperscale contract worth RM23mil from Baidu. This is probably through QCL which was only a 16.67% associate company at that time.

Even though total shares of Krono will increase to 738mil following the acquisition, the allotment of shares to the vendor will be done in 3 tranches as well.

Upon the completion of acquisition, 35.3mil of new shares will be issued to the vendor. After that, 55mil & 20mil shares will be issued after the financial results of FY22 (ends in Jan22) & FY23 (ends in FY23) respectively.

If QCL achieves RM8mil net profit warranty for its FY22, total shares of Krono will increase to 718mil shares.

Lets assume that Krono can deliver RM25mil net profit for FY22 (FY19's PAT RM18.5mil + RM6.7mil from profit warranty), EPS will be 3.5sen.

At current share price of 63sen, forward PE ratio will be 18x.

Krono seems to be in the "sunrise" business of "cloud" but as I'm not familiar with this industry, I'm not sure whether its business model is viable.

As I only hold a little shares of Krono, I think it's better for me to wait and see how well can it grow its business organically in China.

Surely I'm not going to sell at a loss now.