- First time in many years, Vitesse (VTSS) is growing revenues, expecting profitability and is in a net cash position
- Growth rate of leading indicators like design wins and new product revenues is accelerating
- There is a big gap between earnings potential for 2014 and street's expectation of a loss
- Near-term, the stock has potential for more than 50% gains
Vitesse Semiconductor Corp. (VTSS) stock has not done much in the last few years. For last many years, Vitesse was a technology company with negative growth and a net debt position in a sector that was going through capital expenditure constraints.
Much has changed in the last few months to warrant an in-depth analysis. Fundamentally, the company has turned the corner and this momentum is firmly standing on four pillars
- Top line growth
- Improving balance sheet
- Conservative expectations
Technology stocks usually follow design wins and gross margins. Rarely does an investor go wrong following them and by that count, Vitesse seems firmly in position for better times with gross margins close to multi-year high and design wins accelerating.
The company has an S-3 filed with the SEC to raise funds up to $75 million. Any fund raising related weakness may be an opportunity for investors, as has been proven for the participants of the last two equity offerings. The company raised funds in December 2012 at $1.75 and June last year at $2.15/ share.
Revenue growth is back after many years
Vitesse needs little introduction, but it's imperative to note that the revenue profile has changed and product revenues have started to grow again. Vitesse has reached at the cusp of what Christopher Gardner, Vitesse CEO, calls a "traditional hockey stick" growth in its recent conference call.
Revenue growth by product lines
Total product revenue
The total product revenue of 4% was nice, but the trends underlying this top line growth are even more encouraging. Analyzing the trend, a few things become clear.
- Growth is sustainable
- Growth rate should accelerate in the next 2-3 quarters
- Revenue growth to get even more diversified with Chinese and smaller customers coming online. Currently, top 10 customers make up 50% of the revenue.
From a broader market standpoint, Carrier and Enterprise networks more than ever have an increased demand for more and "smart" bandwidth, due to:
- Enhanced mobile networks,
- Cloud based services,
- Convergence of voice, video & data
- Content rich services
- Ethernet deployment within networks or Internet of Things ((IoT))
Leading indicators suggest a sustainable growth
Interestingly, the stock has not done much since 2010; the last year company's revenue grew. This makes the sustainability of this recent revenue growth trajectory worthy of a closer inspection. Growth of new products and new design wins are among the most promising signs of this trend.
The new products are ramping nicely
Sales from new products launched are one of the most promising indicators for a long-tailed revenue growth story for any technology company.
New product revenue growth
New product Rev as % of product revenue
For the last few years, new product revenues have grown at close to 80-90%. The company is expected to make $55 million in revenues from the new products in this fiscal year and has made close to $9 million in the first quarter, which suggests that revenues from new products should really accelerate in the next three quarters.
With new product revenues at more than 30% of product revenues and growing at close to triple digit rates, current street estimates of 10-11% of revenue growth for 2014 may prove to be conservative. The new product revenues have mainly been from design wins of 2011-12 and the company has realized less than 25-30% of the total lifetime revenues from these design wins.
Source: Vitesse presentation
Design wins, a leading indicator for new product revenues, are trending nicely
Design wins are one of the best leading indicators of the revenue growth and the same holds true for Vitesse. For Vitesse, design wins take an average of 24 months to go into initial production and up to 60 months for full production.
Source: Vitesse presentation
The rate of new design wins has been strong. After growing by 40% last year, design wins have increased by 25% in this quarter over the same quarter last year. In fiscal 2013, the company won first designs at over 100 customers and added 30 new customers in the past quarter alone.
The design wins in the last few quarters should start to drive revenue growth rates by the end of this fiscal, which should push the revenue growth rates higher.
Products that can keep this growth going are
Trends that can give a fillip to the revenue growth are the following:
- Switching products to stay strong
- Internet of Things design wins to start materializing into revenues
- Enterprise to maintain momentum
- The Carrier segment may finally make a comeback in the second half
Switching products, the fastest growing category, also hold the most potential for revenue growth with design wins growing by more than 100% in 2013. Revenue for switch engine product portfolio, which can be deployed into Carrier, Enterprise and IoT segments, grew 50% in the last quarter and is expected to grow by 100% this year.
Internet of Things
Internet of Things is one of the biggest opportunities for semiconductor IC companies. Gartner, in its recent report, expects 30 Billion connected devices by 2020 from 2.5 Billion in 2009.
Vitesse is not just well positioned to monetize this emerging opportunity, but the pace of design wins can help the company achieve a leading position in the space among other big players like Broadcom Corp. (BRCM) or Marvell Technology Group (MRVL).
IoT designs wins of total
The material revenues from this space should start coming in by the second half this year and should stay strong for a while after that, especially looking at the growth in design wins. Besides the revenue growth, IoT can also help on the gross margins front with 5% higher than the average margins.
Carrier and enterprise markets
Revenue growth by end-market
Carrier market, which has been weak for a while, saw new product revenue growth of 90% in the last quarter and is expected to get better by the second half. The Enterprise market has been decent and is expected to get even better, especially with new product revenues growing at more than 70%. End of Life (EOL) segment has become small enough to not affect the total revenue growth.
After years, profits are back
As per the company, the company should be profitable by next quarter. The goal is very achievable as the following back of the envelope calculation shows.
For $30 million of revenues, Vitesse needs revenues 10% higher than the last quarter. Besides the revenue growth, margin improvement and operating expense reductions should also help.
Street numbers may prove conservative for the year
Besides the profitability, as the worksheet shows, current street estimates for 11 cents loss may also prove to be conservative.
IF target achieved
Share count (M)
Assumptions used in the calculation:
- Revenue growth of 15% instead of 11%
- Gross margins of 63% from current level of 61%
- Yearly operating expense of $62-63 million from $68 million last year
- Full debt payoffs can add 12 cents of EPS but not baked in this calculation
- Expecting interest costs to cut in half
The company has been systematically reducing the operating costs and increasing gross margins. Further improvement in gross margins should come from:
- New product designs that carry an average 5% higher gross margins
- Carrier markets that carry 10% higher than Enterprise gross margins
The balance sheet is in the best shape it has been in years
After two debt offerings, two equity offerings and debt payoffs & restructuring, balance sheet is finally on a decent footing with a net cash position, the first time in many years.
Vastly improved balance sheet
This year, the company intends to further reduce its debt outstanding, which should facilitate the balance sheet and the EPS.
Years of restructuring efforts have started to bear fruit and make it a perfect 2014 comeback candidate. Target of $5-5.5 is based on 2.5-3 times 2014 sales, which are expected to grow at industry leading growth rates.