Between all the unreal growth rates, adventures in auditing and spectacular blow-ups, it has been hard to find China-based corporations with shares that represent good bargains in the current investing environment. However, there are a few Chinese companies with shares that represent the sort of deep discounts that investors typically think of when they hear the phrase value investing.
One of these opportunities comes in the shares of the left-for-dead Actions Semiconductor (ACTS). Brought to market in a traditional IPO in late 2005, the Chinese semiconductor maker almost immediately faced troubles, both legal and operational, as the formerly hot portable electronics sector faced oversupply and bitter competition. Though many competitors merged or folded under the waves of heavy price cuts and lawsuits that flooded the semiconductor industry in the past couple years, Actions survived, though it has taken a dramatic haircut from its $8 IPO price. Now the bruised company's shares can be had for a 70% discount from the IPO, with shares fetching $2.37 today.
The immediate draw to Action's shares is the company's cash balance. The company has a combined $208 million of cash and marketable securities, according to its last annual financial report, which was released in January of this year. This $208 million in cash and marketable securities compares to a market cap of only $170 million, meaning that you get a valuation for the Actions Semiconductor corporation's business operations of negative $38 million. This leaves three options: the company has a terrible business, the stock is undervalued, or accounting fraud is occurring.
I'll address the third option initially. Unlike many Chinese operations, there appears to be a very low chance of accounting fraud at Actions. The company is audited by Deloitte, which provides a fairly strong measure of security. As we all know, there is no such thing as a 100% guarantee, but I think it is quite unlikely that anything funny is going on with Actions' cash balance. I'd be shocked in fact if anything were wrong because if Actions were in fact cooking the books, I think they'd make up some more exciting revenue and profit numbers, as the trends in both these areas were downright ugly throughout 2008 and 2009.
Ruling out accounting fraud, we are left with two options; either Actions' business is horrible or Actions' shares present a decent buying opportunity based on valuation.
Let's take a closer look at what Actions' business is and whether the market's negative $38 million valuation of it is fair. The overview of operations comes from Actions' website, which states: “We are one of China’s leading fabless semiconductor companies. We provide system-on-a-chip, or SoC, products and total solutions for the development and manufacture of personal media players, particularly MP3 players.” Unfortunately, the market for particularly low-end MP3 players chips has tanked and margins have been driven much lower. For a company that was primarily a one product-line operation, things went south in a hurry. Revenues shriveled from $170 million in fiscal year 2006 to a rather bleak $38 million for fiscal year 2010. This $38 million marked another low, even falling below the already paltry $44 million rate for 2009.
However, it appears that while a booming turnaround is not yet underway, at least bottom has been hit. Revenue for the fourth quarter of 2010 was $10.7 million, a significant bump up from the $7.9 million for the fourth quarter of 2009. Another encouraging sign is the huge drop in related-parties revenues from $12.5 million in 2009 to $7.5 million in 2010. While it is too early to definitely claim that revenue is done shrinking, it appears the company is on the right track, as the fourth-quarter of 2010 was quite strong, and the uptick in sales to third parties as opposed to related parties is encouraging.
The company is also starting to gain traction in markets outside its traditional but struggling MP3 player chip market. The company has found success in chips for boom boxes, car audio, MP4 players and has just launched a new chipset for portable gaming devices. The fourth quarter of 2010 marked the arrival of first revenues from the new G1000 gaming product family. While the G1000 saw limited Chinese release in late 2010, revenues from this new system are expected to rise significantly as production ramps up into 2011.
The company's gross margin has continued to remain steadily in the 35% to 40% range with the most recent quarter figure of 37.1%. The company is on the edge of profitability, turning in a $152,000 loss for the fourth quarter of 2010 but a full-year profit of $384,000. The failure to translate the margins into consistent profitability can be attributed to the company's aggressive R&D budget as it attempts to innovate out of the revenue slump it has been facing.
The company has demonstrated a strong interest in maintaining shareholder value, operating a consistent share buyback for several years in addition to a successful effort to keep costs tightly under control. While I doubt the company will ever return to great profitability, the business isn't that bad. It certainly shouldn't have a negative valuation. The company is breaking even now despite a dreadful market for its primary product. Management has shown strong resiliency to survive a terrible pullback in the low-end semiconductor market. If the economic recovery gains a little steam and the company's new G1000 system generates decent revenue, it's not hard to imagine the company turning consistently profitable by the latter half of 2011.
With the company selling at a $38 million discount to its cash value, it's hard to see Actions' shares falling much from their current valuation. While upside may be capped, Actions should trade for more than $2.37 per share. If you value the company's operating business at a conservative 0.5x sales, and add in the company's cash, long-term investments, and property plant and equipment, you get a valuation of roughly $267 million (some balance sheet figures are from 2009, so give or take a few million) or roughly $3.72 a share. The company's book value is listed at $3.77. However you value Actions Semiconductor, with its shares presently at $2.37, it seems to be a bargain worth picking up if you are looking for conservative exposure to China.