I’ve been lukewarm to the possibility of investing in broadly defined technology companies. Semiconductors fall into that category. That doesn’t stop me from finding some interesting names. The industry is volatile, subject to obsolescence, and competitive. With those risks, the short term perspective of the market can be to your advantage. Supertex is a cash rich company with a history of profitability that popped up on the 52 week low list. There’s a lot to like about this company, but I’m not sure those factors can make up for not fully understanding the business.
Supertex was founded in 1976 by the Pao family, who still play a role in the firm. Supertex makes chips for medical, imaging, LED, industrial, and telecom equipment. For example, they have focused on niche markets such as medical ultrasound imaging and backlighting for LCD displays. The company has been profitable for the past 10 years, although sales have range bound for the same period. Supertex has continually invested in R&D, spending 10-23% of their revenue annually over the past 10 years and has come out with ~20 new products annually in the past few years.
The stock popped up on the 52 week low list earlier this week and when I took a brief look at the financials, I noticed it had a huge cash/investment pile of just under $170m and no debt compared to a market capitalization of $270m. While further digging and the nature of the business reveal that it wouldn’t be prudent to just net out the cash balance, cash has just been building up on the balance sheet for the past 10 years. The company announced a $60m buyback, which seems to be the proper use of cash as the stock price is languishing. The most recent 10-Q reveals that they already $2 million worth of shares in the short time between the filing and the announcement, so it looks likely that it isn’t empty rhetoric.
The company has earned $12m in the past 12 months, so it trades for about 23x net income, which is not cheap. They’ve been able to pay for R&D out of revenue, so most of the cash is not very crucial to the running of the business. Additionally, capital expenditures are minimal with about $30m over the past 10 years. The cash/investment balance deserves a close look though because $32m is in frozen auction rate securities (ARS), the result of yield chasing on their cash balance. At least it wasn’t squandered on a ridiculous acquisition. That figure was closer to $60m until this year, although the balance of ARS could remain stuck for years. Luckily they don’t need the liquidity. The $138m balance of cash/investments is in cash or municipal bonds.
While one could still entertain the notion of valuing the company by netting out cash, the real problem with doing so is that earnings are not recurring in nature and are based on the success of future products. Management has expressed optimism in their most recent products, which focus on the LED and ultrasound market. The sales of LED chips have been growing 100% YoY, albeit from a small base. The company believes that as its ultrasound chips get designed into equipment, sales will surge. The company would probably not notice if $100m of that disappeared, so the market is valuing the business at $170m or 14x earnings. While the company trades at 9x earnings when you net out all of the cash, those earnings are of a more dubious quality than Full House Resorts or Artio Global. This might represent a good deal if you are comfortable with the future growth prospects.
The company allegedly serves niche markets, so one might conclude that the markets can be profitable due to a lack of competition. I only say "allegedly" because I don't know enough about the industry to judge the competition. Intel or Texas Instruments has no interest in a $20m chip market because it wouldn’t move the needle. Their gross margins and net profit margins are in the 37-60% and 4-22% range over the past 10 years, respectively. Clearly there is a cyclical component, but one might conclude that this means they’ve never been in hypercompetitive markets. They also have a portfolio of patents which provide some protection. The company has been in operation since 1976 as well, so the long record of earnings is comforting, although it is not a long record of consistently strong earnings.
The problem with this competitive position and strong past earnings is that the market itself is ever changing. Even though the company spends a lot of money on R&D, it is to replace products that are constantly becoming obsolete. Samsung, GE, and Motorola represent 40% of sales. This can be sticky if Supertex’s chips get designed into their products, but those 3 consistently release new products. This dynamic of constantly innovating and updating products could likely be sustained by the company due to its sustained profitability and large cash position, but the need to do so makes the business less attractive as an investment. The company writes off a few millions worth of inventory each year due to obsolescence, further supporting the case that the business is rapidly changing, although it doesn't restrict profitability too much. They do possess patents on many of their products though, so it may help ensure that the new products they do design are the only ones incorporating their technology and reducing competition.
Management and the board are respectful of shareholders, which is a pleasant change from the norm. The CEO and SVP are the remaining founders still involved at the company. Pao, is part of the founding Pao family. The father was the initial CEO, and his estate still holds several million shares. There was also another relative who used to own a portion of the company that has since moved on. Henry Pao, the current CEO, owns $20m worth of shares and the SVP owns $4m worth. The entire management team is very fairly compensated. Every few years they are granted options, which ups their pay a lot ($800k-900k), but most years pay is in the $300-400k range. In my unscientific casual observations, that’s rare for most $270m companies or companies that make ~$10m a year. Board compensation is also fair.
I do think that the combination of a long history of operations, strong cash position, supposed leading position in niche market, aligned management, and recent buyback all bode well for the stock and business. Try reading this though and tell me you aren’t left completely confused as to what their products do. It's not like an internal combustion engine, which involves some science/technology but I understand. I’m comfortable not understanding the science behind semiconductors or drugs or geological formations, but I couldn’t even tell you what these semiconductors do. Taken from a snapshot perspective of the financial statements, I understand well enough what is going on, but from the perspective of the business as a dynamic entity I am stumped. As the company is not exactly distressed, an investment in Supertex is contingent on future results which are much more likely to stray from past results due to the nature of the business and semiconductors falling out of my circle of competence.
No comments:
Post a Comment