Tessera Technologies (TSRA) is a company you have probably never heard of but you likely use its innovative technology on a daily basis. Tessera is a California based license company focused on leading miniaturization technologies that are transforming next-generation wireless, consumer and computing products. The company’s packaging and interconnecting solutions offer new levels of semiconductor shrinkage by enabling smaller, fully featured electronic devices. Its imaging and optics solutions provide low-cost, high-quality camera functionality in electronic products including image sensor packaging, wafer-level optics and “smart” image enhancement intellectual property (IP).
In today’s smart phones, Terssra’s core products are its miniaturizing services that help the baseband processors, multimedia processors and application processors, each with a few hundred input/output (I/O) to several hundred input (I/O). The high demand for smart, small, hand held devices that’is driving today’s technology companies to innovate new ways to create a finer pitch, increase the data speed and increase processing on a device that consume less battery energy, simply means that most of the electrical engineered parts, around cellphone technology, must constantly be miniaturized.
Step 1 - We first search for companies with pristine balance sheets.
Like many other next generation licensing companies that we are following, Terssera has become a cash machine. Terssera has one of the industries most desirable balance sheets. They have $437 million in cash and investments or $8.71 per share with no debt. If you take the cash out, that gives Tessera an enterprise value (the value of their ongoing operations), of $7.04 and this is a very low enterprise value for a company with tremendous gross margins, compared to its industry, that are topping the 90% range. Realizing the enterprise value is $7.04 and earnings were $.45 per share non- GAAP, the earnings were only 16 times the enterprise value, based on only one, the last quarter. The second quarter was so strong that the run rate (current quarter times 4) is $1.80 per share. Tessera’s enterprise value is under 4 times it’s run rate. Net cash provided by operations was $24.2 million for the 2nd quarter 2010, annualized this number and it’s roughly a whopping 27 % return on it’s enterprise value.
Step 2 - We like extremely low values.
Tessera is one of the lowest valued licensing companies that we have identified. The enterprise value per share is only $7.04, but last quarter's profits was $.45 per share giving Tessera a yearly earning run rate of $1.80. Averaging next years earning forecast (with cash) is $1.54 per share thus future Price to Run Rate of around 9.3 and a Price to Earning of 10.36. If you take out the cash, as typical buyout transactions do, it's trading at about 3.9 times enterprise run rate and 4.5 times future enterprise profits. These are very low considering the last five years they’ve had exceptional profit growth with over 30% annualized growth in profit. Knowing the higher rate of returns for the enterprise, this could make them an excellent take over candidate. If the acquirer could stream line administrative and marketing into an existing company, these synergistic savings would only be additive to the enterprise high returns, thus greatly increase internal returns significantly above the 27% range. Which for most, cash rich technology companies, is an outstanding return over money market rates.
Step 3 - Is the operation or enterprise driving value to their shareholders?
Tessera has had Year-over-Year growth of:
- 20 % growth in revenues.
- The best quarter of revenue, excluding settlements, in their history
- Tessera forecast next quarter of 20% to 24% over third quarter 2009 revenues
- They bought and began integrating a new company named Siimpel to provide a larger bundle of services to the camera module market.
These are very nice operational performances metrics, even in a good economy. Tessera is starting to do the right thing for shareholders. They have been executing very well now for two quarters, while proving excellent returns for their business. This was the second, very strong quarterly performance in a row, and they appear to be accelerating. Tessera 2nd quarter 2010 earnings per share were $.45 beating the Thomson Reuters I/B/E/S estimate of $.25. The revenue forecast was on target at quarter end, but Tessera raised that forecast on June 2 by at least 12% and the earning per share was 80% above the above estimate.
Step 4 - Is this a good business?
Very much so, yes.
Micro-electronics is the company's largest division accounting for 87% of revenues. This division had year-over-year growth of 17% for the 2nd quarter ended 2010 and management is guiding analysts expectations to around 25% growth for the next year. That higher growth forecast was made in the same presentation when Tessera declared several of their larger clients might achieve volume reduction. Tessera, which draws about 95 percent of its revenue from royalty and licensing fees, receives royalties from a host of companies some of the larger known companies including Intel Corp (INTC), Nokia (NOK), Sony Corp (SNE), Samsung (OTC:SSNLF), Motorola (MOT) and Siemens AG (SIEGn.DE). This royalty model has allowed Tessera to achieve the highest operation margin in the Semiconductor Equipment Industry of 40.6% for the trailing 12 months.
The camera module, which represents 12% of revenues, services a market about 1.3 to 1.5 billion units annually and Tessera is anticipating that the market will expand quite dramatically up to 3 to 5 billion units over the next three years to five years. Tessera revenues year over year in this sector are up 43%.
Ultra thin cooling is a new market and a very unique low cost quite approach to cooling laptops and flat screen televisions. Tessera is indicating this segment might be materializing soon.
Tessera is a very valuable and almost a monopolistic market judged by its past licensing success. There are very large barriers to entry both physically, legally and financially with few direct global competitors. Successful licencing company's, because of their large margins and industrial leverage, often trade at a premium to their peers in a growing economy, due to their impressive earnings power.
Step 5 - Is the Train Wreck and then the fog from the Wreck clearing?
When finding companies with a very low enterprise value, often a "Train Wreck" is needed to drive value close to cash. We identified 4 major issues that has kept the value so low:
1. Licensing Lawsuits.
2. Misunderstanding of the business model.
3. Camera market below previous forecast.
4. Internal stock options.
1. In licensing lawsuits, it is very hard for even the experts to predict accurately the outcome of each case, making future earning much less predictable and often lowering the value. Our experience with companies like Qualcomm and Arm Holding, has demonstrated to us, that this a great way to leverage an entire industry. With that said, Tessera has an Hynix antitrust action that has been arbitrated for three years and is expected to go to trail soon along with Amkor arbitration case. Amkor first arbitration took roughly three years and to simplify it for our readers, it’s basically starting over again but this time it seems even more complex. With both cases materialising, the legal cost could and should again start to grow.
2. This is a misunderstood business model that has provided some extremely profitable companies. We call it the shingles versus gutters approach. The gutters are able to leverage all the shingles when collecting rain, giving Tessera the ability to leverage many great leading edge industries needing miniaturization like smart phones. This is giving Tessera a combination of industry leverage with whooping profit margins, few technology companies could achieve. The companies making the phones do all the designing, selling,manufacturing, testing and inventorying while making only a small margin off each unit. Tessera gets a small royalty off every unit, but since licensing companies have such little costs, we’ve seen greater profits, per unit, from the high margin licensing company, than the low margin manufacturing, on the very unit the manufacturing company did by far the greater majority of work and investment.
3. Even though the camera market is expanding rapidly for Teressa and the industry, management is lowering its $100 million 2011 optical forecast. Though this is a small and rapidly growing market, 12% of total sales, they were able raise the 2010 revenue guidance repeatably during this time period.
4. Top management seems to be using the stock option plan increase management pay, that might be against the shareholders best interest. Management appears to be increasing their base pay with a constant diluting of shareholders value due to the stock option plan. It appears that the compensation of Teressa management needs to be changed to reward employees in a way that entrenches corporate values in-line with shareholders. Structure the risk and rewards for holding Teressa stock over a extended time period, not a short term cash machine, like management seems to currently be doing.
We enjoy companies that can provide outstanding short term execution while in this case provides a superior profits and business model.
We believe Tessera has value, strong execution, and a very desirable balance sheet like the past firms that have fit our model. We're optimistic that Tessera will have a similar outcome knowing other companies that fit this model have performed well. They have completed excellent quarters and have attained organic growth of assets.
We have provided some ratios to help value Tessera:
The annalist average enterprise sales estimate is $ 315 million.
|Price to Sales||1.20||3.29||3.83||2.37|
1. The average analysts revenue estimate is $292 million for 2010 and $339 million for 2011 according to Zacks. Again we use an average combining 2010 and 2011 estimates, creating a revenue estimate of $315 million, understanding we are beyond the halfway mark of this calender year. With a gross margin of of 92.37%, compared to the industry average around 52.4%, the average price to sales ratio for Tessera is 1.20. While other high margin licensing companies we follow trade at 5-6 times sales (the industry average of 3.29 times sales) the $315 million average analysts forecast gives Tessera a price to enterprise sales value of $20.72, then adding in the cash of $8.71 gives a value of $ 29.66 to become valued equally to it’s industry peers.
The annalist average profit per share is $ 1.54 estimate
2. The average analysts earnings forecast is $ 1.24 for 2010 and $1.85 for 2011. We are using our $1.54 knowing which is the midpoint of the estimates knowing again we are half way through the year, plus the current run rate is 1.80 or much higher. If Tessera traded at the industry average PE of 20.64 times $1.54 (our average of earnings estimates) the enterprise value would be about $31 dollars per share while adding the $8.77 of cash gives them industry based stock market value of around $40.00.
|% Gross Margin||92.37||52.45||54.42||44.61|
3. Buyout, since past buyouts have been able to strip out the cash, as occurred in the DivX merger, with the enterprise valued at $7.04 and earning $.45. If a buyout company can use established operations to gain economies of scale while reducing marketing and administrative costs, we believe possible returns from the enterprise could well exceed the 27% cash flow from the enterprise, thus in a buyout the current returns would be about 4x the current costs of traditional leverage financing and a far greater return that cash rich companies are currently getting sitting on their cash.
We believe simply that Tessera is trading at about an 80% discount to many of it's Average Industry peers using our worst case sales valuation method. They have a superior model which is gaining the highest industry operational margins and proven profit growth of over 30% in earnings for the last 5 years. We find Tessera’s valuation surprisingly low given their, outstanding balance sheet and cash, great industry leverage and robust growth environment considering the overall economic conditions. This combination of leverage, high margin, strong earning and balance sheet history, plus it’s servicing an true organically growing industry should place Tessera at a premium to its peers, not a substantial discount.
Disclosure: Author long TSRA