Mepcon merger the last throw of the dice for QEOS?

• Gives up 3.3% equity for 60% stake in M&E player with US$11.5mil revenue
• Technology and systems know-how to be applied to boost margins

COULD it be that the answer was right under our noses? That the initial lift-off for a high-tech company from a developing country lies not in selling its solutions to the global market, but in marrying its technology and systems knowhow with the low-margin but established brick-and-mortar businesses that dominate the business landscape?
 
Malaysia is about to find out as Quantum Electro Opto Systems Sdn Bhd (QEOS), a company in the Internet of Things (IoT) space merges with M&E (mechanical and electrical) contractor Mepcon Sdn Bhd.
 
“These guys have the track record and a strong network with banks and customers, while we have the technology,” says Dr Gabriel Walter, founder and chief executive officer of QEOS which he launched in 2008 in Melaka, a small Southern state in Malaysia.
 
A Malaysian who was working in the United States after graduating with a PhD, Walter’s return was boosted by a RM4-million (approximately US$1-million at current rates) grant from the Malaysian Government.
 
Yet it begs the question why, Mepcon, a company with RM45 million in revenue in 2014 according to its founder Dennis Yong, would want to merge with QEOS, a company which, as much as it touts its high-tech credentials, earned less than RM2 million in revenue last year. [RM1 = US$0.26]
 
Falling margins is the answer, with Yong of the opinion that the business was headed down the road of commoditisation. This was coupled with the realisation that the M&E business just isn’t sexy and would command a low PE (Price Earnings) multiple should it go for a listing.
 
Which is why, in an interview with Digital News Asia (DNA) on Wednesday, Yong says he is “willing to sacrifice” giving up a 60% stake in Mepcon, which will be renamed Qeostron Sdn Bhd, in exchange for 3.3% of QEOS.
 
Based on the par value of Mepcon, that puts the 60% at being worth RM6.6 million. “This then gives QEOS a conservative valuation of RM200 million,” Yong points out. The actual value of Mepcon is higher based on its track record of six consecutive years of profitability and current book order of RM100 million. The deal is also premised on Mepcon hitting a guarantee profit of RM5 million this year. [Updated]
 
Yong also paints a scenario where, should Qeostron go for a listing on Bursa Malaysia, it will likely earn a PE in excess of 30 times.
 
These are the reasons that have compelled Yong, whose combined business interests spread across at least 12 companies raked in a claimed RM200 million in 2014, to take a bet on Qeostron that is now a bone fide high-tech and ‘sexy’ company backed by QEOS, with its estimated 100 patents, Silicon Valley engineering expertise, and knowledge of putting systems together.
 
Part of the deal, Yong says, is for Qeostron to be primed for a listing within the next two years.
 
While Yong is clearly excited about the strengths of Qeostron from a corporate point, Walter is looking at the immediate value that QEOS can bring to the table, especially to Mepcon’s LED (light-emitting diode) lighting business.
 
“We are creating strong opportunities for them,” says Walter (pic). “Because right now, the entire M&E industry doesn’t understand the technology and are putting systems together at prices they don’t understand.
 
“We come in with our technology as a manufacturer and provider. As we also understand the costs much better than them, we can determine if certain components are overpriced or if we can make them ourselves,” he adds.
 
Coming from a technical background, this is the big advantage QEOS offers Mepcon, Walter stresses.
 
Such is his confidence in the value the joint venture will create, that Walter predicts Qeostron will see the impact on its bottomline within the first three months.
 
And if for some reason there is no impact to the bottomline within six months, there is a walk-away clause for both parties. In essence, Walter is putting a six-month deadline on a deal that he thinks, if successful, could propel the merged entity to a billion-ringgit business.
 
If this seems a bit premature, Walter insists it is not.
 
“We have already looked at their systems and know that we can immediately help increase their margins and profits,” he says.
 
Using a LED lighting system Mepcon is building, QEOS can reduce the cost of the system by 40% by building a better LED system and also increasing the lifespan of the bulbs.
 
With contracts in hand and a RM100-million order book, all at prices already fixed, any savings QEOS can extract go straight to the bottomline of Qeostron.
 
“It all looks very good in theory,” Walter acknowledges.
 
“I hope the value comes through when we execute,” he says, admitting that he has been frustrated by the slow progress QEOS has been making in terms of revenue.
 
If it does become a success however, Walter and Yong could well be the pioneers in South-East Asia, showing the way for how a high-tech company can unlock its potential by merging with an established old economy play and ramping up its efficiencies and innovation.
 
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