On Friday, shares of Himax Technologies (HIMX) tumbled as much as 10% on the heels of a bearish article, which was released on Thursday evening. Unfortunately for those who sold near the lows, the article contained several factual errors, which we will address in this article.
Specifically, we believe the article presented inaccuracies regarding 1) Himax's status as the optics provider for Google (GOOG) Glass, 2) the ASPs and margins Himax should garner, and 3) the method by which HIMX shares should be valued. We also believe the article lacked recognition for mounting evidence that HIMX will be featured in upcoming products from Microsoft (MSFT) and Samsung (SSNLF.PK), among others. Most notably, we have collected proprietary evidence that HIMX is supplying Microsoft for its upcoming Xbox Goggles.
For The Record
To date, HIMX has not stated that it has the Google Glass contract. However, we believe this is due to the fact HIMX management is under a non-disclosure agreement and therefore legally obligated not to comment. In fact, our prior Seeking Alpha report provided near irrefutable evidence that HIMX is already in Google Glass. A subsequent Digitimes article has confirmed that Himax has received LCOS orders for Google Glass.
Prior to these reports, investors were subjected to conflicting data. Specifically, bearish reports are still citing outdated views (which have since been updated) of Karl Guttag, one of Pipeline Data's trusted contacts. At one point, Guttag doubted that Google would use HIMX LCOS for production, but subsequently reversed his stance and now strongly believes that HIMX is powering Google Glass.
Investors have also been urged to view HIMX's current business negatively. This would be a mistake. Our latest analysis shows that HIMX's core business is actually gaining more momentum, not less. Indeed, driver ICs are currently in short supply and HIMX's shipments of WVGA driver ICs to Samsung are on the rise. Further, we believe that Samsung's design trends favor HIMX's driver IC technology, which will lead to further share gains for the company.
More importantly for investors, Wall Street's estimates currently have plenty of cushion for upside surprises. Management has been unable to discuss its recent dealings with Google, Microsoft, and Samsung. As a result, sell-side analysts have largely chosen not to bake them into their models. Therefore, these deals will be additive to HIMX's results and could represent substantial upside to consensus estimates. It should also be noted that HIMX's 2014 EPS estimates were raised this week (by 12-cents to 54-cents, representing 42% growth over 2013).
Another contentious point revolves around whether Google Glass will be a hit or not. Negative views focus on customer unfamiliarity, privacy concerns, and price. Some believe that the development community will be deterred by this.
We respect speculation. In fact, we do not claim to know if Google Glass will be a hit or not. However, we can (and do) scour the marketplace for clues. In that regard, we have taken notice of a report, released last Wednesday, revealing that Google Ventures, Kleiner Perkins, and Andreessen Horowitz are teaming up to invest in developing the Google Glass ecosystem.
We would have a difficult time identifying a triumvirate more wired into the future of technology. Each of these three entities has a long and storied history of successful foresight and investment. Incidentally, TechCrunch intimated that "the hope of this collective effort is to kick-start the developer ecosystem for Glass and bring it to mainstream users as soon as possible."
The report went on to confirm that Google will start shipping within the next month, far earlier than many have previously expected. The implications of this for HIMX revenue and profits should obviously be viewed positively.
Running The Numbers
For all of the inaccuracies circulating in the marketplace, we believe the most flawed assumptions of short sellers involve valuation.
First, EBITDA valuation comparisons have been made against MagnaChip (MX) and Intel (INTC). There are several problems with this. Among them, MX and INTC are not proper comps to HIMX. MX is a competitor for commodity driver-IC business, but not for the high-margin, high-growth LCOS business. Further, bearish comparisons are conveniently backward looking, which provides no consideration to emerging optics products. Looking ahead to 2013 and 2014, HIMX's EBITDA will ramp higher (and grow much faster) than many of its current comps. Specifically, neither MX, nor INTC have HIMX's growth trajectory. MX is expected to increase EBITDA by roughly 20% in 2014, while INTC's is expected to grow by just 10%.
In comparison, we expect HIMX's EBITDA to swell by 50% in 2014 (on top of a 25% increase in 2013) and challenge the $150 million level. Though our numbers are admittedly optimistic, they are only slightly higher than Wall Street's consensus figures. Thus, short sellers are not only discounting HIMX's future EBITDA, they are also giving no comparative credit to HIMX's growth rate.
Another short-thesis error is in the incremental EBITDA analysis. Bearish assumptions project 15% operating margins and $10 revenue for every unit of Google Glass sold. Both figures are severely off base. As we have publicly stated previously, HIMX is likely to receive closer to $20 per unit on initial orders. Lower prices will come with higher-volumes, but those higher volumes will also carry higher margins. Note that our information comes from industry sources which can and have been accessed by most analysts who have done their proper due diligence.
Based on our proprietary research on HIMX's LCOS margin profile, we believe that incremental operating margins will be substantially higher than 15% (double that would be closer to the target). As for unit shipments, our latest research suggests that management is looking to expand its capacity to 7M units. Thus, a better estimate of HIMX EBITDA on 7M units would be on the order of 25-cents per share. This is substantially higher than the 5-cents that bearish reports have implied.
Needless to say, the impact of an additional 20-cents of EBITDA is material to the stock. Not only does it represent higher EBITDA, it also implies a higher growth rate for the company as a whole. As we mentioned above, Street estimates call for 54-cents of EPS in 2014, up 42% from 2013. These figures alone (which don't account for Google, Microsoft, or incremental share-gains at Samsung) could justify a $12 valuation by applying a 0.5 PEG ratio and adding back HIMX's cash balance. If one chose to use a more Cramer-esque PEG ratio of 1.0, they would derive a valuation in excess of $20.
These sentiments were echoed in HIMX's latest investor presentation. In it, the company outlined its "strong smartphone and tablet growth momentum," along with its "substantial business opportunities from non-drivers, including CMOS image sensor, touch panel controller, and LCOS micro display." It highlighted a "focus in mobile devices with great growth potential" and its "low P/E compared to peers."
In our opinion, this explains the rapid ascent in HIMX's share price. The company's cash balance and 2014 earnings outlook provide a solid floor under the company's valuation. Meanwhile, its deals with GOOG, Samsung, (and likely MSFT) represent a free call option, which could be worth more than the entire business as it exists today. This is the definition of a low risk / high reward situation.
We cannot predict when HIMX might achieve our $12+ price target, nor the path it will take to get there. However, our target remains in place and our latest round of research urges us to revise the figure upward, not down. In the meantime, Friday's intraday drop retraced more than half of the stock's recent breakout. Considering the faulty catalyst for that decline, I personally used the opportunity to double my position and continue to believe that shares of Himax are poised to triple.