Investors Recognize ChipMOS Arbitrage Play



The arbitrage gap between ChipMOS Bermuda and ChipMOS Taiwan is beginning to close.

I believe that ChipMOS will repurchase a large number of ChipMOS Taiwan shares from ChipMOS Bermuda investors using a recent loan.

Business is booming across different segments including gold bumping, DRAM, NAND, and NOR.

On April 11th, the day before ChipMOS's (NASDAQ:IMOS) secondary offering in Taiwan, I suggested that the corporate streamlining process would allow investors to benefit from an arbitrage play between the NASDAQ and Taiwanese listings of the company. The stock moved sideways until late May. Since May 22nd it's been up every day but two, and I believe this is partly due to arbitrageurs seeking to close the gap between IMOS and, and partly due to increased exposure in Taiwan resulting in new highs for the company on both exchanges.

The Arbitrage Gap

ChipMOS Bermuda (listed in the US with the symbol IMOS) has $100 million in cash and owns 522.02 million shares of ChipMOS Taiwan (60.38% of the company listed in Taiwan with the symbol At the moment, is trading at NT$43.05, and the exchange rate is $1 = NT$30, giving a net asset value of $849.1 million. There are 29.78 million shares of IMOS, and a further 2.38 million in employee stock options, which gives an asset value per share of $26.40. Add in another 80 cents or so that will be gained when the employee stock options are exercised at an average value of $11.50, for a final value of $27.20. That's still a little above the current share price of $24.89, but closer than it was. The parity price will fluctuate based on the fluctuation of the price of ChipMOS Taiwan.

The Next Opportunity

Although the arbitrage gap has nearly closed, I believe the next stage of the process will present yet another opportunity for ChipMOS investors. Reuters reports a rumor out of Taiwan that ChipMOS has taken out a loan for NT$10 billion ($333 million) at around 2% interest, payable in 5 years. I believe that ChipMOS will use this cash to buy back a portion of the shares owned by ChipMOS Bermuda at the time of the conversion of IMOS shares to ADRs. ChipMOS is net cash positive with $404.2 million in cash (around $100 million in ChipMOS Bermuda, the rest spread between ChipMOS Taiwan and ThaiLin), with just $202.5 million in debt (mostly in ChipMOS Taiwan), not counting the new loan. If ChipMOS were to use the cash from this loan, as well as a bit of the cash from its continually growing horde, it could acquire around 40% of the ChipMOS Taiwan shares held by ChipMOS Bermuda investors, or around a quarter of the total number of 8150 shares. This would magnify future earnings by a third. Analysts in Taiwan are expecting forward earnings of NT$3.30, and this would increase to around NT$4.50 with such a buyback. The Taiwanese price target of NT$50 for ChipMOS Taiwan shares could be expected to be raised considerably. Such a buyback would only be done at a premium to the current price, as Bermuda law requires 70% approval for the proposal to succeed. It would be a win-win for investors on both sides of the Pacific, as IMOS investors would get paid a premium for a portion of their holdings in ChipMOS Taiwan and would see their remaining holdings increase in value, and ChipMOS Taiwan investors would enjoy the benefits of a large buyback done at a reasonable price. I would also note that this could be done with little risk as the company would make enough to pay back the loan within four years at the current rate of free cash flow generation. If the company does indeed use the loan this way, I believe it would be a very smart use of capital. I expect that investors will receive such a proposal within the next few months.

Booming Business


At the same time as investors can expect to continue to benefit from the corporate streamlining process, business is booming. I've spoken with ChipMOS CFO S.K. Chen and am told that they expect to begin doing NAND testing for Toshiba (OTCPK:TOSBF) in the third quarter, although I would expect the business to ramp slowly given the typically conservative nature of Japanese corporations. Little or no capex will be necessary for this contract as ChipMOS already has sufficient (fully depreciated) memory testers. Incremental margins for testing are very high since there's little in the way of materials involved -- the expense is in equipment.

Gold Bumping

Perhaps an even larger revenue opportunity, Samsung (OTC:SSNLF) is now a gold bumping customer, and ChipMOS management expects them to become a top 10 customer within the next 12 months. It can't be stressed enough how important this area is for growth. There are only two companies in the world with 12" wafer gold bumping capacity, ChipMOS and Chipbond, as well as a couple of smaller competitors that only have 8" wafer capacity. Every display driver in the world passes through these lines, including drivers for smart phones, tablets, laptops, and the recently booming field of televisions. New Ultra HD TVs use 2 to 4 times as many drivers as traditional HD TVs and only cost the consumer as little as 20% more, which should quickly drive adoption. ChipMOS will undergo further capex this year to increase monthly 12" wafer capacity from 24,000 to 32,000, but then their space for expansion runs out. What happens to ChipMOS's pricing power when there's not enough capacity to go around? As one analyst observed in the recent earnings call, capacity is currently fully utilized.

Jerry Su - Credit Suisse

Hi, good evening. S.J., S.K. I have two questions here. First probably goes to S.J. I noticed that the pumping utilization in Q1 is already at 90% and I believe that in Q2 that will continue to increase.

So could you help us understand what is your strategy or plan regarding the [bumping] CapEx or capacity expansion in the - because based on my understanding, all my modeling utilization was at the peak 100% in this quarter. What should we expect on your [bumping] capacity for the second half of this year?

S.J. Cheng - CEO

Thank you, Jerry, it's a very good question. Currently, our capacity is around 130,000 wafers per month based on a range and a tonnage combination. And we are going through above on that capacity investment to increase our output and also through the engineering effort to further reduce our cycle time. So we are going to reach around 165,000 wafers a month.

The majority increase will be the range. And we see them at a high generation rate. So you can compare with [bumping] wise the CapEx we are not increased much and output will be continuing to increase. So that will further improve our gross margin in [bumping] area.

Ultra HD TV Shipments


While it's been widely reported that DRAM has been in tight supply, even NOR flash, a chip category that had nearly been left for dead, is seeing a recent resurgence from Winbond, Macronix, and Spansion (CODE) Spansion was a top ChipMOS customer before the recession, but after a breach of contract and bankruptcy, ChipMOS was forced to sue for damages. Spansion emerged from bankruptcy in 2010 and remained a major ChipMOS customer, and now is seeing great success in both automotive ICs and the Internet of Things.


ChipMOS's US and Taiwanese stock prices have begun to show less disparity. Management continues to work towards simplifying the corporate structure, and I believe that they will simultaneously use cheap debt to do something that investors have long clamored for -- repurchase a large amount of stock. Meanwhile, business is booming across every segment. I continue to believe that ChipMOS is significantly undervalued and should head higher as multiple catalysts converge.

Disclosure: The author is long IMOS. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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