Sigma Earnings Analysis: Shorts Should Soon Have to Cover

Overdue for a compelling stock analysis, my selection today is Sigma Designs (SIGM). The once highflying designer of IPTV and Blu-Ray chips is an unnecessary casualty of this tech-hating stock bludgeoning bear market. I propose, in a market where players like Netflix can thrive and hold to their growth multiples, why can't a chip designer like this at least get a fair multiple? After all, most of this company's products end up outside the US. This is at minimum a $40 stock, and even fairly valued at $74. This, I believe is a play on market psychology and the desire of perhaps one big player to protect an unrealistically bearish and overexuberant short position (Sigma doesn't hold CDO squared positions).

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This recent chart data tells a story of a 3 month ago earnings surprise, levitated largely by likely overordering in the 4th quarter of a major customer, then the following price deflation from both a falloff of a speculation top as well as perhaps some inside knowledge of this inventory situation. According to the March 12th earnings call, disappointing revenue guidance of 60M versus 76M gave the shorts a tad bit more confidence for at least a little while. This 16M miss was entirely caused by a major customer overstocking chips in the most recent quarter, needing some time to work through its inventories.

According to Sigma's guidance in last night's earnings conference call, revenues 60M for Q1 09 is expected, then resumption of previous trends are expected. In other words, we're still at a 300M-350M revenue prediction range with an expected profit margin of 50% for FY09.

Some on the napkin calculations (I'll leave the more precise predictions to the paid analyst community at large) reveal operating expenses likely at 56-60M with reduced legal and Sarbanes Oxley compliance costs and a 10M revenue line from interest income on their gigantic 275M cash position (not bad for a 706M market cap company).

At 50% margin for 325M, a midpoint, we conclude 162.5M in gross profit for FY09. Back out 56M for operating expenses, put back in 12M for interest/investment income, and back out 35M for taxes. We get 83.5M+ of net income against 31.6M shares.

That is a handsome $2.64 net income per share for FY 2009 on a $22.80 growth stock with a 46% y/y revenue growth assumption in businesses with plenty of upside. That gives a paltry forward PE of 8.63. A 30 forward PE realistic for an aggressive price target based (considering growth rate is 46%) on this revenue growth (half the full 45 multiple) gives you a $79.20 price target.

Lets say the bears (note this short interest equals 33% of the total stock's supply at 10M+ shares) are right and growth is done and next year's revenues are 240M? Keeping opex and margins the same, a definite bearish scenario, we get 120M gross profit - 56M opex + 10M interest - 25M taxes ... 49M net income. That is still nearly $1.55/share in earnings, or an 14.70 forward PE. Considering the economies of scale here, a 30 forward PE is more than justifiable considering previous year revenue growth was at a stunning 142% percent! That gives you a conservative $46.50 price target. Even a 25 multiple gets you a $38.75 price target. More than reasonable.

Short Interest

So there you go - price targets of $46-$74 in varying scenarios. With this recent short interest (and likely this is outdated considering recent down volume and institutional ownership on the stock, perhaps more than 10M shares are short now), pictured below, from Nasdaq Trader, I can't help but think someone needs to cover a giant position soon into big news. Can't hurt that by Friday a new 2M share buyback will be eligible. (note the buyback will change share counts down, so any possible lost interest will be more than offset by earnings increase per share)

Disclosure: Long

Comments

[Michael B.Krause]

I've made a few corrections to account for correct taxes, multiples. Although at 21.15, the current price, they are non issues.

[jackiestuart]

Michael... as you said in your "analysis" you should leave the research to the professionals. Please come back with an analysis of the competitive dynamics and ASP trends before you come up with pie in the sky revenue estimates.
There is a reason this stock is heavily shorted. Look at the history of other single application semiconductor stocks like SIRF, TRID, GNSS, SGTL. All had big market share of rapidly growing markets. HAD being the operative word....

[Michael B.Krause]

Go to the 2007 annual earnings report (with 90M of revenue).
You don't have to be a rocket scientist to figure out that even a repeat of that year with .24/share of earnings with a 20 PE gives you a 4.80 valuation. But on top of 300M assets reserve, this company now can leverage itself into many directions. Combine the book value with that 4.80 valuation at you have the most ridiculous price target of about $15/share, assuming earnings decline from 240M to 90M.

So why would anyone in their mind be short from $20? You don't need any sophisticated ASP trend analysis to reveal that there's really an unfavorable risk:reward profile for a short position at these prices. Even if the Needham analyst is right, and SIGM's 300-350M guidance for FY09 is unrealistic (due to overall market weakness / demand limitations), even back under FY08 #s still yields an extremely viable business.

The burden of proof now lies with the shorts now -- nothing past a superficial balance sheet and cash flow analysis is necessary to support the long case, simply because this valuation is so absolutely out of whack.

[xoxogamble]

Fourth quarter ASP's and gross margins are often effected by volume rebate discounts that are triggered when a customer's YTD volume passes into a higher discount bracket. When the next quarter begins the product price reverts back to the higher price and the ASP and gross Margins rise.

Sigma remains a top growth stock with guidance calling for 50% growth this year. With limited IPTV set top manufacturers, one major customer can cause lumpiness form quarter to quarter which is wjat's happening to SIGMA next quarter. But it will be back to double digit increases quarter over quarter begining the second quarter.

[Nom De Plum]

Michael - I read your back of the envelope valuations with P/E ratios and PEG ratios, yet you really don't know what your implying. I actually think it's reckless for you to post. Have you taken a finance class? Or did you learn your valuations from the school of Jim Cramer? A P/E ratio makes an assumption not about next year or the year after, but into perpetuity. It's a trader's way of doing comparable valuations and not an investors method for valuing the future cash generation of a business. As a previous poster mentioned, the SIGM story is no different than SIRF, GNSS, etc. The only reason SIGM went to the $70s was because momentum investors were playing "hot potato" in ahot market. Even they knew SIGM will eventually trade at cash once the story plays out. Back to back years of triple digit growth and now double digit growth, well we've reached the second derivative and everybody is jumping off the ship and investors like yourself can't understand why based on its "P/E" and "PEG" ratios. Take a look at TRID. Two years ago TRID grew revs at 148%, this year revs are projected to decline. What P/E would you put on that? I'm just trying to help you out and others that might read your post and think that there's some merit to what you're saying.

[Michael B.Krause]

Very nice ... Jim Cramer ! Why resort to the low blows? Are you short?

I'm not advocating buying a hot potato here. 143% growth is definitely not in the cards, but even a 25% growth rate is realistic going forward. 3-5 years out = perpetuity as far as the stock market pricing mechanism, anyway.

Even a meet at 300M for FY09 is 36% growth y/y. Impose that over a typical curve ... 36 ... 25 ... 20 and you get a multiple somewhere in between, with a price target way above currently trading prices.

SIRF's margins after operating expenses are attrocious. Furthermore, the IPTV business is nascent, in the very early stages. Sure, there's always commoditization pressure of any chip product (and may I dare venture to say that GPS consumption is much more saturated than IPTV or Blu-ray), but surviving semi companies adapt with R&D and innovation. They now have a cash hoarde to be able to adapt.

Blu-ray is another story entirely -- and even a fractional ownership of the market with accelerating adoption a year or two out spells an entirely new source of growth.

[Jay]

57% of their operating expenses went to R&D in the last fiscal year, which should provide some comfort that they can react nimbly to fast-changing industry dynamics.

[rjbullock]

How does SIGM look toe-to-toe with Broadcom? Is BRCM likely to kill them in a few years?