After its recent earnings announcement, Silicon Motion Technologies (SIMO)-- one of my favorite mobile plays-- has fallen nearly 15%. It is now trading at unbelievable forward P/E of 6.4 (4.2 excluding cash!). Intrigued, I searched through my various watchlists (152 stocks in total) to find companies trading at similar valuations. First I searched for companies that had 15% or better top and bottom line growth last year, this year, and projected for next year. Then I looked to see how many of these companies traded at a forward PE of less than 8. Out of 152 companies, I only found one other company, Velti (VELT), a different type of mobile play. Given VELT's after hours sell-off yesterday, it seems destined to follow in SIMO's footsteps. The company offers us a bleak reminder that stock prices do not always reflect current earnings or future earnings. They demonstrate market irrationality and how earnings expectations / estimates trump investment fundamentals.
Silicon Motion Technologies Corp
SIMO is a fabless semiconductor that derives 2/3 of its revenue from mobile storage and communication solutions. SIMO delivered 69% revenue growth 2011 and is on track to deliver 25% revenue growth this year. Its EPS growth has been just as impressive and is on track to earn 1.77/share this year. It is currently trading at $12.55 and it has approximately $4.50/share in cash with no debt.
Prior to this quarter's earnings release it was trading between 14-16 dollars a share. At that price one would have assumed any disappointments were well baked in. Third quarter results beat expectations (revs 77.1m vs 74m, EPS of 54 vs 46), but 4th quarter guidance came in below expectations (71-74m vs 77m) and gross margin guidance disappointed (44-46% vs 47-48%). During the conference call, the company gave the following guidance for 2013:
- Gross Margin decline would be limited to 2 quarters.
- Revenue growth of at least 15% Y-O-Y.
- LTE transceiver growth of 50-75% next year.
- eMMC controller market share to double.
In summary, we have a company growing 25% this year, at least 15% next year, trading at a PE of 7.7, but since guidance missed, the market decided that it was now worth 15% less...
Velti is a mobile advertising company. It grew revenue by 65% last year and is on track to deliver about 60-65% revenue growth this year. Its adjusted EPS was $0.50 last year and is estimated to be $0.73 this year. Velti is different from Silicon Motion Technologies in that it is still struggling with GAAP profitability but should breakeven this year. Before Wednesday's earnings release it was trading at $6.64, giving it a forward PE of 7. With 60% growth rate and such a low PE you would really expect that a disastrous disappointment had been baked into the price. After the earnings release yesterday it fell 25% to nearly $5.
For the 3rd quarter Velti beat on revenues $62.4m vs $62.0m but missed EPS estimates (-0.03 vs 0.03). It also announced that it would divest from its Greek, Balkan, Middle East, and North Africa assets. The impact on revenue and adjusted EBITDA is expected to be $10-15m and $6-9m, respectively, leading the company to guide below expectations (97 - 113m vs 121m). Despite this, Velti still guided for positive operating cash flow in the fourth quarter with approximately neutral free cash flow.
What is surprising about Velti's after hour action is that the stock has been trading at a discount because of concerns over DSOs, free cash flow, and exposure to troubled Euro assets. So while the divestiture will hurt the company in Q3,4 of this year, it was made to address investors concerns and will help facilitate 2013 free cash flow generation and reduce DSO. It will also streamline Velti's financing structure and make it a more attractive buyout candidate. I am pretty sure that a larger company would have found exposure to such assets as a detractor / liability. Additionally, there were many positives in the conference call:
- Guided for mid-30% growth rate for 2013 consistent with estimates.
- There would be no need to raise capital given the improvement expected in free cash flow.
- The company estimates that every quarter next year will produce neutral to positive free cash flow.
- It is looking at signing several multimillion dollar deals in Q4 and Q1.
In summary, we are left with a company that has grown 65%, 35% next year, now with an improved outlook of free cash flow for 2013 that is trading at forward PE of 5.5.
Despite impressive earnings and revenue growth in 2012 , Silicon Motion and Velti's share price has declined 39% and 20% YTD, respectively. Yes each company has had its share of disappointments but fundamentally they have had a strong and successful year. Silicon Motion should be trading in the 22-30 dollar range, while Velti should be trading in the 10-17 dollar range. Why sophisticated markets and investors have decided to be influenced by naive earnings expectations rather than fundamentals is difficult to understand. Ultimately, I believe that long term both these companies offer great opportunities to the patient investor with a possibility of 100% returns. SIMO is the safer bet, but VELT maybe far more rewarding. However, I am still left asking myself, if the market prices fail to reflect earnings, then what do they reflect?