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Shareholders of OmniVision Technologies (NASDAQ:OVTI) can be forgiven for looking ahead to 2012. The stock capped off a miserable year by hitting a 52-week low after releasing fiscal second quarter earnings on Tuesday afternoon. Revenues of $217.9 million actually exceeded the company's pre-announced guidance (pdf) range of $212 to $217 million, while earnings per share of 35 cents were not horrific, though they did include a one-time 14 cent gain due to an operational acquisition.

The problem was that the company had originally guided for sales of $255-$275 million and GAAP earnings of 42-54 cents per share in conjunction with first quarter earnings (pdf) released in August. And that projection so spooked investors that the stock gapped down some 30%, tumbling an additional 40% since then. All told, OVTI is off over 70% from its 52-week high set in March, closing Wednesday at $10.79.

Truth be told, it's surprising that the decline is not even larger. The stock is up nearly 4% for the week despite Tuesday's report, and the guidance that went with it: revenue of $160-$180 million, with GAAP EPS between a gain and loss of 6 cents, down from 75 cents in earnings for the year-prior quarter. Wednesday's blowout market day likely took out the sting; the stock had been down 12% after-hours Tuesday, before regaining much of its losses during Wednesday's trading.

Besides the back-to-back earnings disasters, one of the main drivers of the stock's decline has been its place -- or lack thereof -- in Apple's (NASDAQ:AAPL) iPhone 4S. Originally, it was theorized that OmniVision's image sensors would have 90% of the business in the new iPhone. Then, the August earnings miss led to fears of dual-sourcing between OmniVision and Sony (NYSE:SNE), fears that seemed to be justified in October. Chipworks cracked an iPhone 4S, finding a Sony -- and only a Sony -- image sensor inside, sending the stock down 9.4%.

The company's response to the speculation has been silence. In response to a general question on the August conference call, VP of Worldwide Sales Ray Cisneros offered the following:

Raji Gill – Needham & Company

But has that extension resulted in share loss in the smartphone market?

Ray Cisneros

Well, I mean, I can’t comment for any individual customers and we don’t breakdown sort of the way we back into particular customers, but I can tell you this that when we have our plans we work very closely with our customers. Our customers understand what our plans are. And so far we have a plan in place and that’s about the extent we could say on that.

Despite the vast focus placed on the OmniVision-Apple relationship, it is worth pointing out that in its two previous 10-Ks, the company has not listed Apple as a 10% customer. (Foxconn and LG were the direct 10%-plus customers in FY2010 and 2011, respectively.) In 10-Qs, various customers are alluded to as 10% customers, though not by name. In the annual reports, Omnivision has listed one distributor as a major customer: Taiwanese reseller World Peace Industrial Group. Given Apple's attention to detail in its sourcing requirements, it seems unlikely that the iPhone maker is routing its orders through a relatively unknown, overseas third party. As such, according to the SEC filings, an investor must assume that Apple represents less than 10% of OmniVision's revenue.

This begs the question: why is the market so focused on the Apple relationship if Cupertino is not even the company's largest customer? Or, is the company lying? The company is facing a class-action lawsuit for its failure to accurately disclose the still-unresolved nature of its current relationship with Apple. But the SEC rules surrounding "10 percent customers" are far more ironclad than the disclosure requirements that would seem to surround the Apple relationship. The company can justify its reluctance to discuss specific customer and/or supplier agreements in conference calls and earnings releases (those agreements are often subject to confidentiality clauses); but its omission of Apple from SEC filings would seem to prove that Apple business falls below the 10% threshold.

Of course, there is more to the drop in stock price than just the Apple relationship. The company's failure to execute on new products, the decline in revenue -- some 35% year-over-year at the midpoint of Q3 guidance -- and a huge growth in inventory in the recent quarter have all affected investor confidence. The company has already marked down some $16 million in inventory writeoffs through the first half of the year, only to see inventory jump by over $100 million in the second quarter. CFO Anson Chan noted that OmniVision "expect[s] to get back to a more reasonable level of inventory in two to three quarters." However, the combination of that higher inventory and the rollout of second-generation sensors should hit margins over the next few quarters. Analysts at Morgan Keenan have already lowered earnings estimates for FY12 and FY13 in response, while Wedbush beat the company to the punch, anticipating weak Q3 guidance and lowering its price target from $14 to $12.

To sum up, it would appear that OVTI deserves much of its 70% haircut over the past seven months. But is a falling knife worth catching? Fundamentally, the company still appears solid. Cash net of all long-term liabilities is $6.97 per share, with twelve-month earnings at $1.71/share including the weak fiscal third quarter guidance. Even at Keegan's low estimate of 57 cents per share for FY2013, the forward enterprise value-to-earnings ratio for the stock sits at just 6.7. In addition, the company's "fabless" business model (where actual manufacturing is outsourced) results in low levels of capital expenditures -- just $10.3 and $13.5 million for FY11 and FY10, respectively. Even at a lowered revenue level, the company should be able to generate cash, particularly if some of the $100 million in excess inventory can be liquidated before it becomes obsolete. Given that the company's enterprise value is just $230 million, the company does not need to return to the levels of growth previously predicted in order to return to cash to stockholders.

Indeed, the stock appears to be priced for failure, quite simply. 60% of OVTI's revenue comes from the still-growing mobile phone market, with the company's focus on eight-megapixel cameras found in most new smartphones. The substantial cash on hand -- and a tangible book value of $12.07, 12% above Wednesday's close of $10.79 -- should provide a downside cushion. And even in the second and third quarters, which have caused so much consternation among analysts, the company should still earn $10 to $15 million on a GAAP basis, over 10% of enterprise value at an annualized rate.

Still, investors should be cautious if they are considering a long play in OVTI. The company's silence on the Apple relationship may be ethical, but caused more drama and shareholder bitterness than needed. (If OmniVision is indeed bound by a confidentiality agreement with Apple, they could have easily released some sort of statement to that effect.) The company's struggles over the past two quarters can be blamed in part on macro issues; but it is clear from reports that customers have lost confidence in OmniVision's ability to deliver its components on-time and in the proper quality. Analyst Daniel Amir of Lazard Capital Markets summed it up perfectly in the most recent call's Q&A (emphasis mine):

Daniel Amir - Lazard Capital Markets

I just wanted to get an idea here. You have been highlighting a number of times in the call that you believe that you can gain back momentum. At least I didn’t hear anything here in the call that really gives confidence here, considering your revenues are down now 100 million compared to just a couple quarters ago.

The numbers for OVTI look better than the company does. The steady streams of reports, the earnings misses, and the vague responses on the conference call do little to inspire confidence, as Amir noted. Indeed, Cisneros' answer to the question quoted above was, simply put, unsatisfactory, noting that OmniVision was "actively engaged with customers" and explaining that "the process is complex." Investors want better answers, as they should.

OVTI bulls should definitely consider the options market as a way to hedge against further bad news, another earnings disappointment, or broad market troubles, which will likely weigh on the stock (OVTI has a beta of 1.61). The January 10 put is bid at 70 cents, offering a 7.5% return and expiring before third quarter results are released, likely in late February. More aggressive investors can look to the January 2013 LEAPs; the January 2013 10 put is bid at 2.50, offering a 33.3% return over 14 months, with break-even at $7.50, near the current cash balance. These hedged plays might be the best entrance to a stock which has disappointed investors for most of the year, and does not yet look ready to truly turn around.

Source: OmniVision: Value Play Or Value Trap?