O2Micro International Limited: OIIM 2.18 [-0.04]
May 11, 2010
O2Micro International Limited (OIIM) Stock Review – A Fabless Semiconductor Company (ADR)
by Randy Durig, CEO of Durig Capital
O2 has built a rock solid balance sheet, delivered several very good quarters with outstanding execution, and became well positioned in a very exciting higher growth clean energy industry. They have a very low enterprise value, PE and price to sales valuation that increase the probability that O2 will achieve a higher reward for shareholders!
We selected O2 because it’s one of the select few that fits our model! Our goal is to select, purchase and monitor companies in an effort of gaining outstanding performing investments while minimizing risk for our clients. We will cover part of our review and selection process as well as explain why O2 has currently become one of our selections.
Step 1 – We first search for companies with pristine balance sheets.
O2 has roughly $111.2 million in cash, or $3.18 per ADR, and no long term debt providing O2 with an outstanding balance sheet (especially for a small but fast growing young company and for the Green services, knowing most companies we review in saving energy space have either a poor business model and/or are bankrupt or severely hurt during the economy’s up’s and down’s). O2 appears to have excelled in this downturn.
Step 2 – We like extremely low enterprise values.
Their enterprise value is $137 million for ongoing company operations. They just completed a single quarter with over $37 million in sales and an 11 cent GAAP profit – where revenue increased by 5.2% sequentially and a whopping 50.8% over the previous year period.
Even better yet, O2 generated $8.5 million cash flow from the first quarter. That works out to be about $34 million annually to where O2′s enterprise value is trading at about 4 times free cash flow annualized. Companies that are involved with leveraged buyouts, after removing the cash, might realize this is a very desirable internal cash generation rate.
O2 has been achieving size, scale and gaining several competitive advantages to where they can achieve scale with the many additional new products they are launching. Even though they had many competitors, they were able to achieve possibly the most validating win in the Green industry – being built into the new Apple computer iPad. Having Apple select O2 for their next generation flag ship product, this solidifies O2 as a technology leader in the low power usage “green” chip industry.
Step 3 – Is the operation or enterprise driving value to their shareholders?
O2 receives another yes. They had an outstanding quarter with an 11 cent GAAP profit, which is significantly above the average estimate of 3 cents. Because of both the cost savings in SG&A and the superior growth in top line sales that they have demonstrated, the future earnings for the entire year should be also significantly improved. The current company forecasts revenues to expand 6-10% sequentially with the possibility of holding to slight margin erosion.
Step 4 – Is this a good business?
This is a simple business compared to many other companies we own, even though Piper Jaffery was quoted saying that the “LED market remains a compelling growth opportunity. The LED market was roughly $6B in 2008 and we expect it to triple to $18B in 2013 (43% CAGR). Growth rates this high in markets this large are rare.” Even knowing O2 is leading some key market initiatives like the Apple iPad, we would be just pleased if O2 achieved parity to many other companies in it’s field.
Not only is 02 positioned well in the LED market but it’s also built into many product solutions where a combined effort and focus of both power efficiency and true mobility allows 02 to have what appears to be a very good position in the confluences of very smart, extremely mobile interactive devices between the Apple iPad and Dell notebook (both O2 clients), that are seeing robust growth now and in future forecasts.
Since O2 is a fabless company, they tend to outperform their fab owner peers when their is excessive production capacity available, like after a hard recession. When fabrications allotment becomes constrained, often the production companies have a stronger cycle. O2 has a very large overall staff of over 60% engineers. They appear proud of this fact, and rightly so if they can always allow the new products released to result in 15% of overall sales and provide such strong revenue growth just shortly after such a strong downturn.
The quarterly business breakdown for 02 is as follows:
- 55-60% of revenues from consumers;
- 25-30% from computers;
- 10-15% from industrial; and,
- Less than 5% from communication.
Step 5 – Is the Train Wreck and then the fog from the Wreck clearing?
When finding companies around half cash value, often a “Train Wreck” is needed to drive value close to cash. With O2, it was priced in a service market and thought that the prolonged legal battle would never end. They are an ADR based in the Cayman Islands with Chinese roots – knowing that many Asian based ADRs often have lower stock valuation benchmarks than US based companies. Several companies over the last years have announced they would be entering the notebook, monitors and TV back lighting’s market assuming it would hurt O2 margins. What’s so surprising is that after new competition arrived hard recession took hold, a prolonged legal fight ended and now it’s hard to find a time period in O2′s history when the margins were better.
It appears that the increased competition has allowed O2 to advance their game plan allowing to show strong growth just after a major recession.
We enjoy companies that can provide outstanding short term execution, while at the same time bring down the costs substantially and attempt to greatly enhance both their growth prospects and business model position with many new products driving their future success.
We believe O2 has value, execution and a balance sheet like those past companies that fit our model, e.g. SONS, SGI, LAB, DIVX, KHD, HCII and WCG. So, we’re hopeful that O2 will have a similar outcome knowing other companies that fit this model have preformed well. O2 has completed two excellent quarters, profitable quarters, and already attained margins over 60%, which was one of their most profitable in several years.
With all the cash, the good business model, profitable execution and high growing company and industry, we still believe O2 is still valued as a model that might not achieve success. Even though we believe O2 is, again, starting to establish itself as an LED, green technology industry and an Apple new product innovator, any one of these achievements in the past have helped companies gain higher valuations. We believe that O2 is undervalued based on the following very basic valuation metrics:
1. Revenue Based
If you value O2 at 3.60 times sales (integrated circuits average) with O2 using a $140 million base sale (or, $13.92 per share) plus the $3.18 in cash currently on the books, it adds up to a $17.10 stock market value.
2. Earnings Based
The integrated circuit industry values the PE ratio for the sector at 23.48. Using the current earning forecast plus the completed quarter, we’re forecasting O2 to have 56 cents. Using the 0.51 times 23.48 we come to a valuation of $11.96 per ADR.
With both models, the low valuation and especially with their short term superb execution plus good industry, large new product launches, Green position and Apple product leadership, O2 could and should, in our opinion, be valued significantly higher.
Durig Capital owns O2 for itself, clients and related client accounts. We started buying around $6.75 per share.
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