My biggest concerns going into the call were inventory and cash management, and the company executed well in these areas in the face of declining shipments.
• No cash burn. This was particularly impressive given reduced product shipments and a bigger decrease in Accounts Payable [AP] over Accounts Receivable [AR].
• Inventory reduced. Shipments were down $2M Q/Q, but inventory was still down in this environment.
• AR days outstanding are at an industry low. Lack of capital forces discipline and it shows here at Vitesse. PMCS AR turnover is 35 days, AMCC 42 days. Vitesse is at 15 days. This is the best indicator that the sins of channel stuffing are washed away, as customers don’t pay quickly for product they don’t need.
• Opex down significantly from $28M to $22.6M. This was achieved through the use of multi-project wafers [MPW], as well as higher levels in the previous quarter due to bonuses paid. Assuming 200 engineers were paid $5000 (numbers I am pulling right out of the air), that would account for a $1M reduction, and mask savings were at least another $1.5M. MPW’s are not without drawbacks, as they slow prototyping and increase production costs. Given the long ramp to volume production in telecom products, this is a sensible trade off for Vitesse to make.
Overall, the increased financial discipline within the company is positive trend reversal. In September 2004, Vitesse had net assets (Current assets - All Liabilities) of $38M. In September 2005 it was -$51M (reduction mostly acquisition related) and today it stands at -100m. $138M of value flushed in two years, not including the $15m or so Tennenbaum is guaranteed either in interest or prepayment penalty.
My remaining concerns are how well Vitesse is aggressively pursuing strategic divestitures that would allow lean resources to be better concentrated in one area. Consolidation is a key theme for us, and the communication semiconductor business is in dire need of it in order to generate incremental shareholder value.
The company indicated financial auditor selection is nearly complete. While this was good, I place greater emphasis on the resolution of shareholder lawsuits, as strategic divestitures cannot (profitably) take place until this is completed. If shareholder litigation was settled and audited results available, this would open up M&A possibilities and allow the value in the company to be unlocked. Re-listing the shares is irrelevant to this outcome, other than providing a wider market opinion of the asset value.
It was evident on the call that Vitesse continues to value Ethernet products, but stressed their role would be more oriented towards the telecom business.
The CEO, Chris Gardner, said this:
We have begun the efforts to focus our development on our core communication business, building on the synergy of the Ethernet and Network divisions.
It isn’t clear exactly what this means, but interpreted literally would indicate the company is de-emphasizing storage. In the face of radically reduced opex, some divestiture is needed in the short term in order to extract maximum value from existing assets.
I assign the following valuations to Vitesse, based on my thesis from last fall. These are my own numbers and are not investment advice. I consider them conservative. You must form your own opinion.
• Networking - 2x Revenue. This is low when compared to companies like PMC-Sierra (NASDAQ:PMCS) and Transwitch (TXCC), and in-line with companies like AMCC (NASDAQ:AMCC) and EXAR (NYSE:EXAR).
• Storage - 3.5x revenue. PMC-Sierra paid more for less when it acquired Avago’s storage group. Even annualizing the most recent quarter, I arrive at a $240M price tag.
• Ethernet - $60M, down from the $100M I predicted last fall as the division has certainly depreciated in the absence of heavy investment. The decay rate of Ethernet products is high. Valuation here highly dependent on the acquirer. The value of eliminating a price competitor could be higher to some companies like Broadcom (NASDAQ:BRCM).
Using these figures, I arrive at a valuation of $1.90-$2.00.
Disclosure: Author is long VTSS.
VTSS.PK 1-yr chart: