DSP Group (NASDAQ:DSPG) is a little known innovator in the semiconductor industry. The company dominates the market for audio chips that fit into cordless phones with 80% worldwide market share. The cordless business is the company's cash cow needing little incremental investment and throwing off lots of cash. According to the company's 2015 10-K, the Home business, the vast majority of which is the cordless business, did $122 million in revenue in 2015 and generated $25 million in profit.
The company's first growth business is its mobile segment. In this segment, the company sells chips that go into watches and mobile phones where they perform audio functions such as ambient noise suppression and voice recognition for voice commands. DSPG's edge is that its chips draw much less power than its competitors, which is very important to phone and watch makers who want to extend battery life as long as possible. It has been a long road for DSPG in this market as it has been working on these chips for three years without any significant market traction.
In the past six months, however, the company has garnered two major design wins that will in and of themselves be large revenue generators but will also give the company increased credibility with other potential customers. The first was with the Samsung (OTC:SSNLF) Gear S2 watch. This is a lower volume win as the category is still nascent but provides some revenue and was a beachhead into Samsung. As has been revealed by recent teardowns, a DSPG chip is also present in the recently launched Samsung Galaxy S7. The Galaxy S7 comes in two versions; one with a Qualcomm Snapdragon processor and the other with a homegrown Samsung Exynos processor.
Current thinking is that the DSP chip is only in the Snapdragon version which is being sold in the US and China. If you assume 20% of roughly, 50 million S7 units are sold with DSP chips at $1 ASP per unit, then you get a $10 million per year revenue stream to DSPG from this model alone, which is in line with the company's guidance. This compares favorably with the zero revenue that this segment did in 2015.
The company is now engaged in discussions with other Android phone makers who often follow Samsung's lead when it comes to adding components to their phones. For comparison purposes, there was a public company called Audience that did $160 million in revenue in 2013 from this type of business alone. That gives you some idea of the upside that is possible from this segment.
The next segment that DSPG operates in is the office segment. Here the company sells chips that go into Voice-over-IP business phones, which is about a $200 million addressable market. The company did $20 million in revenue in this business in 2015 and has guided to 50% growth in 2016. There is a favorable business dynamic here as the two market share leaders in the space, Broadcom and Texas Instruments, are both getting out of the business and DSPG is taking advantage through market share gains.
The company also has a play on the Internet of Things in the home. It has a low-power communications technology that it derived from its cordless business called Ultra Low Energy (ULE) that has superior characteristics versus most competing home technologies. While small last year (about $4 million in revenue), this is potentially a very large market should the company gain traction here.
Finally, the company recently introduced a new product called the Spark PA, which is a power amplifier designed to go into next generation Wi-Fi access points. This is a standard CMOS part so can be produced less expensively than the current generation of SiGe and GaAs parts. Besides its cheaper cost, the part also outperforms the competition, setting it up for traction in the $1 billion market for these devices.
After a solid first half of 2015, the cordless business suffered a weaker second half and guided to a very weak Q1 2016. In addition to fluctuations in end demand, this market has also suffered historically from inventory buildups and reductions in the distribution channel. This combination has led to lots of volatility in DSPG's cordless business over the years. Management believes that what it is seeing for Q1 is a combination of weaker end demand plus distributors reducing inventory. Investors have taken the stance that this is a worsening of the normal rate of decline in this business from 10% to 20%. I think this negative view is currently the base case for the stock and if the business does come back, it will be upside for shareholders.
So what is DSPG worth? The company currently has a market cap of $200 million with $122 million in net cash. The growth business will have an aggregate revenue of about $50 million in 2015 and be growing at close to 70%. There are no public comps growing that fast but with slower growers valued at 3x sales, I think 4x is a reasonable multiple for these businesses. For the cordless business, I think 0.5x sales is fair. Finally, you get a free option on Spark PA, as it is tough to value at its nascent stage. So,
- $122 million in net cash
- 4 x $50m = $200m for the growth businesses
- 0.5 x $122m = $60m for the cordless business
- $362m for everything vs. a $200m market cap today
- $15.63 stock price target meaning 77% upside
Disclosure: I am/we are long DSPG.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.