Having voluntarily given up the big pie of the communications market, what is the future prospect of Kaiwang Technology?

Jiwei.com reported that 259 days after being accepted by the GEM Listing Committee, the IPO process of Henan Kaiwang Electronic Technology Co., Ltd. (hereinafter referred to as "Kaiwang Technology") is still in the "inquiry stage".

According to the article "【IPO Values】Kaiwang Technology, which focuses on the security market and has a single revenue structure, faces soaring risks in major customers" recently released by Jiwei.com, Kaiwang Technology's current performance mainly comes from the security market. With its top five customers accounting for more than 90% of its operating income, orders from a single customer, Hikvision, have accounted for nearly 50% of its total revenue in the past three years. 

With its performance heavily dependent on a single customer, the revenue of the "communications market" that made it famous plummeted. In order to ensure the production capacity supply for major customers, Kaiwang Technology even proactively gave up the order volume in the communications market and only maintained a moderate scale.

However, judging from the global distribution of connector applications, the communications industry accounts for 22% of the overall connector market, and the security industry is far smaller than the communications market. Kaiwang Technology's strategic adjustment is like "picking up sesame seeds and losing watermelons." Judging from its current market situation, it seems difficult to recapture the communications market and open up new markets.

Actively give up the "communications market"

It is understood that Kaiwang Technology's technological accumulation originated from 10 years ago when it was founded. In 1999, its actual controller Chen Haigang established Shenzhen Kaiwang (currently a wholly-owned subsidiary of Kaiwang Technology) in Shenzhen, which mainly engaged in the research and development, production and sales of precision cable connection components, and gradually established a stable production management team.

In 2001, Shenzhen Kaiwang successfully entered ZTE's supplier system and maintained a long-term cooperative relationship; 10 years later, in 2011, after passing Dahua's strict product technology, quality and other certifications, Kaiwang Technology successfully entered Dahua's supply chain system and achieved mass supply.

It was precisely because of becoming Dahua Technology's supplier of precision cable components that Hikvision, a security company, took the initiative to cooperate with it and established a preliminary cooperative relationship in 2011. With the gradual rise of the fourth-generation mobile information system in 2013, Kaiwang Technology, relying on its advantages in digital transmission connectors, achieved mass supply to Hikvision.

Before 2011, Kaiwang Technology's largest customer was ZTE, and its downstream application areas were mainly the communications industry. However, with its continuous development in the security field, after 2014, its revenue from security precision cable connection components exceeded that from communications precision cable connection components.

Limited by the production capacity and capital scale at the time, it was unable to meet the needs of ZTE, Hikvision and Dahua Technology at the same time. Considering the future development space of downstream customers and its own competitive advantages, Kaiwang Technology gradually focused its resources on the security field, while maintaining a moderate scale in the communications field.

However, from the perspective of market size, Kaiwang Technology's decision is puzzling. According to the website of the Electrical Connector Branch of the China Electronic Components Industry Association, in 2018, automobiles, communications, and consumer electronics accounted for a large proportion of the global connector application fields.

Among them, the automotive industry accounts for 23.6% of the global connector market; the communications industry accounts for 22% of the total market; consumer electronics accounts for 13.5% of the total market; other applications account for 21.6%, and the security industry is included in other applications. Compared with the communications industry, the market share of the security industry can be described as the difference between "sesame and watermelon".

For example, Yihua Co., Ltd., a domestic connector company mainly engaged in the communications industry, had operating revenue of 1.623 billion yuan in 2019, while Kaiwang Technology's operating revenue in the same period was only 443 million yuan.

Not only that, although Kaiwang Technology currently focuses on the security industry and has successfully entered the supply chain of leading companies such as Haida Yutian, its current market share in the domestic security equipment electronic precision cable connection components is still relatively small.

According to the "2019 China Connector Market Competition Research Report" released by Zhiduoxing Global Electronic Components Industry Research, the demand for connectors for security in China in 2018 was approximately 4.06 billion yuan, and in 2018, Kaiwang Technology's security precision cable connection components achieved revenue of 339 million yuan.

From this, it can be inferred that Kaiwang Technology's security precision cable connection components account for 8.34% of the domestic security equipment electronic precision cable connection components market share.

According to data released by the China Industry Information Network, the global market size of Chinese connectors in 2018 was US$20.9 billion. Assuming that the communications industry accounts for 22% of the total market, the market size of China's communications industry in 2018 was US$4.598 billion (RMB 29.266 billion based on the exchange rate on March 12, 2021).

Compared with the communications market, Kaiwang Technology's move is really "picking up sesame seeds and losing watermelons". At the same time, the gross profit margin of its communications products is much lower than that of other products in the same period.

Communication products have low gross profit margins

The prospectus shows that in 2018, 2019 and 2020, the gross profit margins of precision cable connection components for communications were 10.98%, -1.99% and 2.63%, while the gross profit margins of precision cable connection components for security were 21.43%, 25.55% and 22.37% respectively, and the gross profit margins of precision cable connection components and others were 19.73%, 37.45% and 23.57% respectively.

Compared with other products, the gross profit margin of communication precision cable connection components is lower than that of other products in the same period.

Considering that its main customer in the current communications market is ZTE, the gross profit margin of products sold to ZTE is used for comparison. During the reporting period, the gross profit margins of its sales of precision cable connection components for communications to ZTE were 17.46%, 9.26% and 10.33% respectively, which are still far lower than the industry average gross profit margin.

In this regard, Kaiwang Technology explained that, on the one hand, ZTE's orders were mainly commissioned to outsourced supplier Huibangsheng for production, while the products sold by the company to other major customers were mainly produced by the company and outsourced suppliers around Shenqiu County. Compared with Shenqiu County, Guangdong Province has higher labor costs, resulting in higher production costs for ZTE's products.

On the other hand, there are differences in production models. The production links of Kaiwang Technology's precision cable connection components mainly include cable production, connector production, and cable and connector assembly. Most of the cables and connectors required for the products sold to other major customers are independently produced by Kaiwang Technology. The cables and connectors required for the products sold to ZTE are basically purchased from outside. Compared with independent production, the cost of external purchases is higher, resulting in higher costs for ZTE products.

It is worth mentioning that the gross profit margin of sales to ZTE is much lower than the average gross profit margin during the same period, which has also attracted the attention of the China Securities Regulatory Commission, and raised the question of "whether there is a risk of losing its major customer ZTE."

In response, Kaiwang Technology stated that there is no risk of losing its major customer ZTE because ZTE's business was affected by the activation of a denial order and production suspension by the Bureau of Industry and Security of the U.S. Department of Commerce, resulting in a decline in operating income and a corresponding decrease in its operating income from ZTE.

From the perspective of customer structure, in the context of a decrease in ZTE's orders, it did not choose to develop other communications market customers, but chose to focus on the security field and completely entrust the production of ZTE's orders to outsourced suppliers.

In the future, with the development of 5G technology, the market space for communication connection components is expected to grow. By then, it will become questionable whether it can quickly respond to market demand, rapidly increase production capacity, and meet the conditions for producing precision cable connection components for communications.

At the same time, it also stated in its latest prospectus that the company will continue to expand the application of its products in the fields of communications equipment and consumer electronics with security precision cable assemblies as the core, making it a powerful supplement to the company's profit growth. At the same time, it will vigorously explore applications in military equipment, rail transit and other fields, and has currently obtained small-batch orders in the rail transit field.

However, judging from the current revenue structure, Kaiwang Technology's market development seems to have not officially started yet, and new performance growth points may take a long time.