Value Play: Silicon Image (Nasdaq: SIMG)

During the California Gold Rush of 1848-52, more than 250,000 people traveled to the Golden State in the quest for riches. All of these gold prospectors had to buy picks and shovels in order to search for gold, but few actually got rich. As one commentator put it:

The mining life was hard. Camp gossip told of miners who grew rich overnight by finding eight-pound nuggets, but in reality, such easy pickings were rare.  Miners spent their days standing knee-deep in icy streams, where they sifted through tons of mud and sand to find small amounts of gold. Exhaustion, poor food, and disease all damaged the miners’ health. Not only was acquiring gold brutally difficult, but the miners had to pay outrageously high prices for basic supplies. In addition, gamblers and con artists swarmed into the camps to swindle the miners of their money. As a result, few miners grew rich.

Although few gold miners got rich, plenty of others did get rich from the gold rush — but it had nothing to do with finding gold. The key to wealth was in supplying the mining tools for all of the gold miners. Mark Twain’s humor was often funny because it was so true and his observation about the gold rush was spot on:

When everyone is looking for gold, it’s a good time to be in the pick and shovel business.

The business insight behind this statement is simply that it is extremely difficult to predict in advance who the winners and losers are going to be in a business endeavor, but the one certain way to make money is to provide all of the competitors with the tools they need to participate in the quest for success.

A modern-day analogy to picks and shovels is intellectual property. Companies that have patents for fundamental components of end-user devices are able to receive a royalty every time a device is manufactured or sold containing that patent item. For example, Qualcomm (QCOM) receives a 3% royalty on every smartphone handset sold because these handsets contain Qualcomm spread-spectrum CDMA technology and couldn’t function properly without it.

Roadrunner is a small and mid-cap investment service ($10 billion market cap or lower), so I can’t recommend Qualcomm because it sports a humongous $122 billion market cap, but it’s worth noting what Qualcomm recently acquired Wilocity, a leader in development of 60 GHz wireless chipsets based on the IEEE 802.11ad standard, also known as wireless gigabit (WiGig) technology. Wireless connections in the 57 GHz to 64 GHz frequency band are super-fast, but cannot penetrate walls and thus have limited range only suitable for open office environments, so WiGig will not replace Wi-Fi in the 2.4 GHz and 5 GHz frequency bands, but it will be compatible with Wi-Fi and supplement it. According to PC World:

The key benefit of 60GHz technology is that it speeds most wireless applications several times over. For example:

• Transferring 1000 photos between notebooks in 5 seconds (versus ~1.5 minutes with 802.11n)

• Downloading a single 1080p movie to a tablet in 3 minutes (versus ~1 hour with 802.11n)

Because it operates in the 60GHz frequency range, WiGig has severe limitations in terms of range. A higher frequency means a shorter wavelength. A shorter wavelength equals higher attenuation, and shorter range. Your Wi-Fi network operating in the 2.4GHz or 5GHz range can extend for hundreds of feet—from your desk to the board room, or from one end of your house to the other. WiGig has a range of about 30 feet.

For specific use cases, WiGig will be awesome. It will compete with other technologies like WirelessHD (which also operates in the 60GHz range) as a standard for wirelessly transmitting audio and video from a tablet or game console to a TV, or from an audio system to speakers. It will be great for living room entertainment because it can free you from the ugly tangle of wires running here and there.

There is going to be a HUGE demand from corporate offices worldwide to get rid of bulky and unattractive connection cables, so the future of 60GHz wireless technology is very bright. As more enterprise customers adopt the technology, the market will expand and there will be plenty of room for competing suppliers, including small-cap companies like this month’s Roadrunner Front Runner for the Value Portfolio: Silicon Image.

Silicon Image is a technological leader in high-speed data connectivity, with over 500 patents in three main product areas, and sales deriving from both manufactured semiconductor components (fabless) and intellectual property licensing:

Source: 10K Filing (page 82)

The competing Mobility DisplayPort (MyDP) connectivity technology has the upper hand on high-end smartphones, but MHL is the connectivity technology of choice for mid-range smartphones that are most popular in emerging markets like China and India. The  MHL platform has grown to an installed base of more than 500 million devices and greater than 300 unique products in the global marketplace.

In 2013, Samsung accounted for 40.2% of total revenue, but no other customer accounted for more than 10%. Samsung is the world’s largest smartphone manufacturer, so it’s a good partner to have, but on the other hand Samsung has lost global market share this year  (25.2% vs. 32.3% last year) and its reduced handset sales caused it to cutback on MHL orders from Silicon Image. On July 8, Silicon Image issued a sales warning for the second quarter, lowering its guidance due to “lower than anticipated mobile shipments to a significant customer” (i.e., Samsung) and delayed royalty payments on its HDMI patents. The stock dropped 14% in a single day on the news.  The good news is that this revenue miss is temporary and will soon reverse. Samsung’s sales slowdown was due to customers delaying smartphone purchases in anticipation of the release of iPhone 6 on September 9th. The cause of the HDMI royalty delay was not explained, but CEO Camillo Martino is confident that the the company will recognize the HDMI royalty payments in the fourth quarter of this year. The stock is still down 30% from its March high of 7.16, so now appears to be a good entry point for the stock since a revenue recovery from the bad news is very likely to occur sooner rather than later.

Perhaps the biggest news coming out of the company’s July 30th conference call is that a 60 GHz WiGig  product is in advanced stages of development:

In the same way that multiple companies provide Wi-Fi solutions for the market today, we expect that there will be multiple companies that provide 60-gigahertz solutions and we continue to believe that we are well-positioned to be a major player in this market.

We believe that Qualcomm’s strategy acquiring Wilocity is to accelerate the adoption of 60-gigahertz WiGig in the mobile market segment. In addition to the wireless HD solutions that we have developed and shipped to market, we also have a WiGig solution planned and we are now in the advanced development stages of this product. Our WiGig solution should be well-aligned with the market ramp of the WiGig standard expected to be in the second half of 2015.

Analysts have voiced concern that Silicon Image is late to the WiGig party, with Qualcomm having a solid 12-month lead. Currently, Silicon Image only sells a WirelessHD 60 GHz product, which looks like it will end up to be the losing “Betamax” standard with WiGig the winning “VHS” standard. After all, Intel abandoned Wireless HD, stating that it is a “video-only application” and WiGig provides more comprehensive high-speed data connectivity. But it’s still possible for the state-of-the-art video connectivity found in Wireless HD to be woven into the WiGig standard somehow and that is Silicon Image’s big hope. The WiGig standard is still hopelessly up in the air, with Intel recently pulling out of Qualcomm’s Allseen alliance to pursue a different WiGig standard under the banner of Open Interconnect Consortium (OIC). This dissension among the WiGig big players is the opening Silicon Image needs to get involved, convincing one side that its video technology can make one WiGig standard more successful than the other. CEO Martino described the company’s WiGig strategy in the conference call this way:

Frankly there are things in the WiGig specification that are still being worked on. And that specifically is the video side, I think the market is looking for a clear direction on the video side of WiGig. And so there is an opportunity for us to professionally participate.

The market opportunity for WiGig as the “Internet of Things” is enormous:

The payoff of this so-called Internet of Things could be staggering, especially for Bay Area tech companies, which already are jockeying to cash in on the trend. Research firm IDC predicts this shift will generate nearly $9 trillion in annual sales by 2020. By comparison, the total annual sales of the Bay Area’s 150 biggest technology companies in 2012 was $677 billion.

“This will be potentially the biggest business opportunity in the history of people,” said Janusz Bryzek, a vice president at San Jose-based Fairchild Semiconductor, who helped organize a gathering of international experts at Stanford in October to discuss the subject. “We are changing the Earth.”

Granted, Silicon Image is a small player in the WiGig industry and not a pure play, but even a small piece of the WiGig pie would be transformational for Silicon Image. Qualcomm paid 30 times sales for pure-play Wilocity and Silicon Image is currently trading for only 1.4 times sales. If Silicon Image gains traction in WiGig, its price-to-sales ratio should at least double (the industry average is 3.0).

A doubling of the stock price appears baked into the company’s long-term target for annual revenue growth of 15-20% and an operating profit margin of 15-20%, which is more than double the current 8% operating profit margin (slide no. 43). Combine strong revenue growth and increased profitability with a strong balance sheet with zero debt (slide no. 44) and Silicon Image is a very attractive investment right now.

Insiders appear bullish on the stock’s prospects, with several having recently purchased stock at higher levels than the current stock price.

Silicon Image is a buy up to $6; I’m also adding the stock to my Value Portfolio.

Sell Alert

To make room for Silicon Image, Roadrunner is selling:

• ManTech International (MANT)

ManTech International posted pretty horrible second-quarter financials, with both revenues and earnings down significantly year-over-year and missing analyst estimates. Even worse, forward guidance for the second half of 2014 was lowered for a second time. In-theater contract work from Afghanistan continues to decline, while new cybersecurity and electronic warfare contracts continue to be delayed. The company’s EV-to-EBITDA ratio has skyrocketed to 47 times thanks to a collapse in cash flow (EBITDA). Granted, much of this cash-flow shortfall is related to costs associated with extinguishing debt, which strengthens the company’s balance sheet and improves earnings performance in the future, but every month the weakest portfolio stock must be eliminated and this month ManTech is the weakest.

When I first recommended ManTech, its EV-to-EBITDA was very attractive (i.e., low) at around five times. Since that is no longer the case, it’s time to jettison this stock and make room for a new value stock that is worthy of the name. 

ManTech International is being sold from the Value Portfolio.

Four Momentum Buys:

1. EQT Midstream Partners LP (NYSE: EQM)

EQT Midstream Partners LP owns and operates midstream natural gas assets in the Appalachian basin, encompassing both transmission and storage. The Partnership owns 700 miles and operates an additional 200 miles of FERC-regulated interstate pipelines, and also owns more than 1,600 miles of FERC-regulated, low-pressure gathering lines.

• Price gain between 12 months ago and 3 months ago = 105.01% (99th percentile)
• Price gain over the past 2 months = -10.07%
• Price gain over the past month = -11.00%
• Roadrunner Momentum Rating: 105.01 – (-10.07) – (3*-11.00) = 148.08

EQT Midstream Partners is a buy up to $99; I’m also adding the stock to my Momentum Portfolio.

2. BitAuto Holdings (NYSE: BITA)

BitAuto Holdings is a leading provider of internet content and marketing services for China’s fast-growing automotive industry. The Company’s bitauto.com advertising business provides consumers with up-to-date new automobile pricing and promotional information, specifications, reviews and consumer feedback.

• Price gain between 12 months ago and 3 months ago = 241.87% (100 percentile)
• Price gain over the past 2 months = 42.13%
• Price gain over the past month = 7.66%
• Roadrunner Momentum Rating: 241.87 – (36.48) – (3*19.19) = 147.82

BitAuto Holdings is a buy up to $70; I’m also adding the stock to my Momentum Portfolio.

3. Panhandle Oil & Gas (NYSE: PHX)

Panhandle Oil & Gas owns approximately 41,000 net mineral acres in western Oklahoma and leases oil and gas drilling rights (87% natural gas) to large, independent oil and gas companies in exchange for both working interests and royalty interests. Panhandle does not operate any of its oil and gas properties.

• Price gain between 12 months ago and 3 months ago =117.30% (100 percentile)
• Price gain over the past 2 months = 1.93%
• Price gain over the past month = -6.99%
• Roadrunner Momentum Rating: 117.30 – (1.93) – (3*-6.99) = 136.34

Panhandle Oil & Gas is a buy up to $75; I’m also adding the stock to my Momentum Portfolio. 

4. Marcus & Millichap (NYSE: MMI)

Marcus & Millichap  is  a leading investment real estate broker with more than 1,300 brokers in 76 markets throughout the United States and Canada. In 2013, the company closed more than 6,600 investment transactions for private and institutional investors, more than any other real estate brokerage firm.

• Price gain between 10 months ago and 3 months ago = 104.09% (99th percentile)
• Price gain over the past 2 months = 2.74%
• Price gain over the past month = -8.25%
• Roadrunner Momentum Rating: 104.09 – (2.74) – (3*-8.25) = 126.09

Marcus & Millichap is a buy up to $29; I’m also adding the stock to my Momentum Portfolio.

Momentum Sell Alerts

To make room for these four new momentum stocks, Roadrunner will be selling four price laggards:

• Inteliquent (IQNT)

• Power Solutions International (PSIX)
  
  
• Pricesmart (PSMT)
  
  
• WisdomTree Investments (WETF)