Eric Singer's Vertex Capital took a 9.9% stake in the small cap memory provider GSI Technologies (NASDAQ:GSIT) back in January. The small activist (managing around $80mm) has nominated four directors for GSIT's board. GSIT is a $136mm market cap maker of memory products.
Now, Singer's Vertex believes the board has been insufficient when focusing on creating shareholder value. Of the five directors on the board before Vertex's involvement, two were founders and one had been with the company for 15 years.
Since Vertex took its stake in January, GSIT has expanded its board to seven, adding two new directors, not Vertex's nominees. The move has been perceived as an attempt to stave off activist pressure and for management to protect its own position.
But shares are up 17% YTD, possibly on the hope that Vertex can reverse a growing trend of underperformance. It's worth noting that Vertex is invested at cost basis around $5/share.
Poor operating results: It's no surprise Vertex sees the need for a shakeup at GSIT. No matter where you look, there's not much to be encouraged by in the company's financial statements. Through the first three quarters of this fiscal year, revenues are down 12%, and losses have nearly tripled, from $800 thousand to $2.2 million. Unsurprisingly, the stock is also down over 15% over the last year.
The company has cited a weakness in the global networking and telecommunications markets as the primary reason for its operational struggles. However, competitors such as Integrated Silicon Solution (ISSI) and Cypress Semiconductors (CY) have been growing revenue and profits, up shares up 22% and 42% over the last year, respectively.
The truth is that GSIT's products are significantly more expensive than its competitors, and its claim to higher quality products has not been able to stem the market share loss. This has been a persistent trend for several years.
Moreover, GSIT has shown questionable management decisions over the past years. One glaring example is a $1 million write down the company had to take in 2013 after management's prior expectations of increasing demand following a favorable ITC ruling on and the exit of a competitor from the SRAM market did not materialize.
Biggest risks: In addition to GSIT's poor results, the company has two significant risks. One, is the ongoing litigation with Cypress Semiconductors, which is accusing GSIT of infringing on several patents. The lawsuit seeks unspecified damages and to stop the sale of several of GSIT's Very Fast SRAM products. The looming uncertainty surrounding the lawsuit has put a proverbial cap on GSIT shares, and the ongoing legal costs are a major drag on earnings. Litigation expense was $1.8 million just last quarter.
The second risk is GSIT's high level of customer concentration. Sales to Alcatel-Lucent (ALU) make up 23% of revenues, and sales to Cisco (CSCO) make up 14% of revenue. That level of dependence on just a couple customers is always dangerous.
The GigOptix offer: Back in August, GSIT received an offer of $6.50/share from semiconductor component manufacturer GigOptix (GIG), a 30% premium to the price at the time. Rather than engage with GIG, GSIT's board refused to negotiate and instituted a management compensation plan that would reward GSIT's executives with over $2 million if the company was acquired and they lost their jobs.
GIG withdrew its proposal in November, more bad news for GSIT shareholders. With no profits, declining revenues, and significant risk factors, it's hard to imagine how the company could justify a $6.50/share valuation (1.5x book value) on its own. A strategic acquisition seems to be the best way to create value.
Where we stand: Vertex is battling a company with litigation risks, declining sales and a bull headed management team (with management owning 20% of the company). This won't be an easy proxy battle and one where the risk/reward isn't skewed in their favor.
Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.
