Wade W. Slome, CFA, CFP is President and Founder of Newport Beach, California based Sidoxia Capital Management, LLC. He managed one of the ten largest growth funds in the country ($20 billion in assets under management) at American Century Investments, and currently manages a hedge fund in addition to separate customized accounts for a selective client base at his firm.
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What is your highest conviction stock position in your fund?
I don’t really have a highest conviction stock, per se, in my fund since I treat all my stocks like children - I love them all. Having said that, NVE Corp. (ticker: NVEC) is a holding of mine that exhibits many of the characteristics I look for in an investment. The Eden Prairie, Minnesota based company is named after “Nonvolatile Electronics,” which refers to memory technology that retains data even when power is removed – a critical attribute for certain applications.
Tell us a bit about the company and what it does.
NVE Corp. is a market leader in nanotechnology sensors, couplers, and MRAM intellectual property (Magnetoresistive Random Access Memory). NVE’s microscopic technology enables the transmission, acquisition, and storage of data across a broad array of applications, including implantable medical devices, mission critical defense weapons, and industrial robots. Major customers include St. Jude Medical, Inc. (STJ), Starkey Laboratories, Inc., and the U.S. Government.
The company’s coupler and sensor businesses have been ridiculously profitable. Even over a period covering one of the worst global financial crises in decades, NVE managed to increase its operating margins from an already very respectable 40% range in Fiscal 2007 (ending March) to a stunning 56%+ level in Fiscal 2009.
Beyond sensors and couplers, NVE Corp. is optimistic about the potential for the MRAM market. However, outside of a few one-time licensing fees, NVE is currently generating effectively zero revenues from this nascent storage technology. Rather than produce the technology, NVE Corp. is looking to leverage their IP portfolio by licensing out the patents and subsequently receiving royalties from the MRAM device manufacturers. MRAM technology uses magnetic fields to record information, but unlike tape recorders in which a short section of tape holds magnetic information, with MRAM data it is held by electrons. Believe it or not, this method is highly reliable and is very power-efficient relative to other storage technology alternatives. Currently, the problem with MRAM is the cost prohibitive manufacturing requirements relative to other memories (such as DRAM, SRAM, and Flash), but costs are expected to come down over time. For some MRAM believers, the technology is considered the “Holy Grail” because it may have the potential to combine the speed of SRAM, the density of DRAM, and the non-volatility of Flash memory in a universal source.
If the unproven potential of MRAM ever blossoms, the broad portfolio of NVE Corp.’s MRAM patents should represent a very sizable profit opportunity. Of course, NVE Corp. must first establish the validity of its MRAM intellectual property and appropriately charge and collect royalties for IP usage. How big can the MRAM market be? Some size the MRAM market in the billions and Toshiba has stated they expect the MRAM market to surpass the size of the traditional memory markets by 2015.
No matter how one measures the size of the market, there will be a substantial revenue opportunity for NVE Corp. if every smart-phone, gaming device and laptop exclusively uses universal MRAM - rather than a combination of DRAM, SRAM, and Flash technologies.
Can you talk a bit about the industry/sector? How much is this an "industry pick" as opposed to a pure bottom-up pick?
Generally speaking, I am a bottom-up investor. I may have concrete views on a particular industry, but the fundamentals of a company will be the main determinant of my investment thesis. Overall, I am looking for market-leading franchises that can sustain above-average growth rates for extended periods of time. These traits can come from either a company operating in a mature, sleepy industry (take for example Google in the advertising world) or from a more dynamic growth industry like nanotechnology in the case of NVE Corp.
I believe the nanotechnology industry is in the very early innings of an innovation revolution with regard to new applications and products. Like semiconductors, the economies of scale and technological advances of NVE Corp.’s “spintronic” technology should continually allow faster, smaller, more reliable solutions at lower bit prices. In my view, this snowballing effect will only increase the penetration of nanotechnology solutions and introduce an ever increasing list of new applications.
Can you describe the company's competitive environment? How is this company positioned vis a vis its competitors?
NVE Corp. has competitors along all three of its spintronic businesses. In their sensor business, most of the competition comes from the makers of legacy electromechanical magnetic sensors, including HermeticSwitch, Inc., Meder Electronic AG (Germany), and Memscap SA (France).
In the coupler space, NVE Corp. faces a larger list of well capitalized, household semiconductor names, including Avago (AVGO), Fairchild Semiconductor International (FCS), NEC Corporation, Sharp Corporation, Toshiba Corporation, Vishay Intertechnology (VSH), Analog Devices, Inc. (ADI), Silicon Laboratories Inc. (SLAB), and Texas Instruments Incorporated (TXN).
A different set of competitors are searching for the MRAM holy grail, including the following companies: Crocus Technology SA (France), Grandis, Inc., MagSil Corporation, Spintec (France), Spintron (France), Spintronics Plc (UK), and IBM.
There is undoubtedly a ton of competition in the spintronics space, but as of October 2009, NVE Corp. has 52 issued U.S. patents and over 100 patents worldwide (either issued, pending, or licensed from others) – many focused on the potentially lucrative MRAM field. Although NVE Corp. has many competitors, they have dominant share in the coupler/sensor market when it comes to high-end, merchant supplied solutions. Moreover, on the MRAM side of the business, the company has already licensed its intellectual property to several companies, including Cypress Semiconductor (CY), Honeywell International Inc. (HON), and Motorola, Inc. (MOT).
Can you talk about valuation? How does valuation compare to the competitors?
Valuation is a key component for all my stock investments. In my valuation work I pore over the income statement, balance sheet and cash flow statement in deriving my price targets.
One area helping NVE Corp.’s valuation case is its improving trend-line of profitability. Over the last 5 years alone, gross margins have gone from 40% to over 70% - not a bad business model if you can execute it. The company also has a pristine balance sheet. Not only does NVE Corp. have no debt, but it also is sitting on a growing mound of cash/investments (over $43 million), representing more than 20% of the company’s market capitalization. Finally, the company in my view is attractively priced on a free cash flow basis (cash from operations minus capital expenditures), yielding around 6% of the total company value.
What is the current sentiment on the stock? How does your view differ from the consensus?
With small cap stocks like NVE Corp., sentiment and lack of liquidity can create gut-wrenching volatility. Unlike many growth investors who pay more attention to positive momentum factors (price direction), I welcome volatility as it allows me to find more attractive entry and exit points.
That said, NVE Corp. hit a peak stock price north of $63 per share in early September fueled by 41% revenue growth in their June quarter (fiscal Q1). Subsequently, in fiscal Q2 (ending September 30th), revenue growth decelerated to +14% causing momentum investors to take NVE Corp.’s shares to the woodshed. With the stock down about -35% from its recent crest, I find the valuation only that much more attractive.
Wall Street estimates are calling for further slowing in revenue growth in the coming quarter, so the short term sentiment may or may not continue to sour. Timing bottoms is inherently dangerous and not something I consider myself an expert at. Absent a major deterioration in fundamentals, I stand ready to add to my position if NVE Corp.’s share price falls and valuation metrics improve.
I would argue the typical consensus view advocates selling shares when revenue growth slows. Many of my best performing stocks have been purchased during transitory periods of slowing or cyclical downturns. Let’s hope that’s the case with NVE Corp.
Does the company's management play a role in your position?
Absolutely. There is a continual debate over what is more important, the jockey or the horse. My investment philosophy puts more weight on the jockey than the horse. Obviously, I’m looking for the combination of a talented management team and a solid business model.
When it comes to NVE Corp., Daniel Baker, Ph.D. has done a phenomenal job managing the hyper-growth profile of the company, while preserving prudent and conservative financial values. For the third year in a row, Dr. Baker was also recognized as one of the best U.S. CEOs in the semiconductors and semiconductor equipment industry by investment research and financial consulting firm DeMarche Associates.
At the end of the day, it’s difficult to argue with a track record of success. Since Dr. Baker took over, revenues have more than tripled, and earnings have grown from $0.01 in Fiscal 2001 to $2.04 in Fiscal 2009.
What catalysts do you see that could move the stock?
Since I hold a longer term investment horizon, catalysts are not a driving aspect to my investment process. But clearly, any additional evidence unearthed in the marketplace validating the growth in the MRAM market, or announcements confirming the value of NVE Corp.’s MRAM intellectual property, should provide support to the stock price.
Beyond that, given where the stock is trading now, I believe merely continuing the execution on their sensor and coupler business provides adequate upside prospects.
What could go wrong with NVE Corp as a holding?
Investing in small cap technology stocks comes with a whole host of risks. Although I don’t believe the positive scenario of critical mass MRAM commercialization is baked into the current stock price, I nevertheless understand any setbacks announced relative to NVE Corp.’s MRAM prospects or the industry’s MRAM expectations will likely result in stock price pressure.
NVE also has significant customer concentration, therefore a loss or cutback in sales from a lead customer will probably contribute to price volatility.
From a macro perspective, the company has battled successfully through the economic crisis and proven itself somewhat recession resistant. Nonetheless, the company has sizeable exposure to the industrial segment and would not be immune from the “double-dip” economic recession scenario.
Surely there are additional hazards to this investment, however these are some of the risks I am currently focused on.
Any closing thoughts?
NVE Corp. is not a stock for the faint of heart. However, for those who can stomach the volatility, I encourage you to do some more homework on NVE Corp. Not only will you learn about a phenomenally managed, very profitable, attractively priced nanotechnology company, but you will also gain insight into a leading force behind the eyes, nerves, and brains powering the electronic systems of our future.
Thank you, Wade.