Sigma Post-Earnings Update: Staying Long, Though Concerns Remain

Since I'm outspoken for my interest in Sigma Designs (SIGM), I felt it would be appropriate to update my take (read recent conference call transcript here).

Of concern to me (and probably every analyst) was:

• Slightly lower margins (45%. 47% target going forward)
• Excessive operating expense in the form of stock option grants
• Decision, whether intentional or not, to no longer give much guidance. Little visibility.
• Because of no visibility, lack of confidence in revenue dependence on IPTV due to inevitable competitive pressures.
• Lack of near term (this fiscal year) success on Blu-ray.
• The obvious bear case going forward: FY 09-10-11 earnings will go into negative trend due to the above mentioned points, specifically from a drying revenue stream from simple inevitable market competition in the IPTV space, thus the below mentioned 12.33 FPE actually becomes anything you'd like to justify (imagine: $1.50, 1.00, .25 earnings for 09, 10, 11). My crystal ball does not say this, but I'm sure every short will argue this as their dominant case.

Bullish points:

• SIGM is diversifying their product mix. You have potential for a win with just one new surprise of market acceptance in any of the product groups: Ultrawideband, Blu-ray, VXP's video processing products, DOCSIS 3.0 solutions, IPTV. Additionally, a substantial asset base lets them organically keep progressing with this diversification.
• The buyback has not been completed yet. 1.2m shares remain. Better per share numbers come with this.
• On the gross margin side, it is important to note that inventory from the VXP acquisition is booked at projected selling price, and this is impacting margin negatively in the short term. In other words, there is likely not substantial real (cash flow) margin pressure, and in two quarters or so we may be back towards 50%. A situation where inventory accounting methods present a picture that is starkly different than cash flow tells.
• Book value of about $10 still remains. This provides a floor. Anything above is where extrapolations on growth trends will occur.
• Even if you had $200M of revenues and $1.50 of earnings, that gives a 12.33 forward PE. If projections are flat year over year performance (versus trending negative), this supports the stock.
• Actually bullish price action on Friday. One can speculate that the short thesis has played out in the near term and shorts finally have a way to cover into large selling now that the unknown is... now confirmed. I can think of a lot better ways to use capital than to force an extra $2 out of the stock. That is 10m shares of buying support. In this case, 'buy the news' as the news is bearish.
• Anyone who owns now has faced these realities fully, and will not as easily part with their shares. The April 2008 Tristan Guerra downgrade call pushed these same issues when the bulk of the longs including myself had not expected such negatives in the face of what was then 325M FY guidance. Now expectations are very different.

On one side you'll have the 'value' justification and on the other you'll have fear of declining earnings and no products left to sell in the future. I am holding my current losing long stock position (I held an options strangle into earnings: I sold the put side. It paid for losses on the call side, so it turned out a wash. Now I own free calls), but will take a wait and see approach. The market sentiment has shifted: the contrarian view (from a fundamentals side) on SIGM is now long.

The counterintuitive way in which these markets function suggests that it may pay to be patient for a long, despite the likely consolidation phase ahead of us. I will be a new buyer at $14 (and recommend this as a strong buy target to new investors) with lower price targets in mind. Call buyers might give it a shot here at 18.50 however.

Disclosure: Long SIGM

Comments

[Nom De Plum:]

Looking forward to the update in a few quarters when you throw in the towel....tell me what was Bear Stearns' book value when it went belly up? FYI, book value is one of the most meaningless measures of value in technology. In a rapidly declinig ASP environment how can you rely on book value when some of its makeup is based on cost? Inventories ballooned 30% on a 20% decline in sales. In two quarters what do you think that inventory worth? $20M of goodwill and intangible assets, what do you think someone would pay for that...I know what I would pay, it's in my wallet and I don't carry $100s. The truth is you know very little about SIGM, it's technology, what it's worth, etc. The company's retraction of guidance shows its own inability to model revenue and corresponding expenses which will result in under investment or over investment. The truth also is that neither do I and that's why I don't tell people to invest their hard earned money or clients' money in a business that has very little transparency and in a sector that is littered with hundreds of SIGMs. I don't mean to pick on you personally, I just think the internet has created a lot of irresponsible mechanisms for dissemanating information.

2008 Jun 02 10:11 AM

[Michael B. ...:]

With regards to inventories from the conference call:
'Inventory was $34.5 million, an increase of $8.2 million over the previous quarter primarily due to the decrease in our shipment and the purchased VXP inventory... (Per the VXP inventory) We book it at its selling value and that was one of the adjustments that I explained to our gross margin. There’s about a $700k gross margin miss or unrealized amount associated the VXP sales during Q1. As we sell through the purchased inventory we’ll begin to get new inventory in that will actually have a gross margin and that will be another positive affect on our gross margin.'

It'd probably be fair to assume at least half of that inventory build was actually the booking of inventory at selling price on the VXP assets (18m purchased).

Still, 28m of inventories is a little over a buck a share to discount. I don't see your point. On the goodwill and intangible, again similar numbers. Thus the $14 strong buy target.

2008 Jun 02 12:04 PM

[User 202507:]

SIGM has been on a death spiral but after reading michaels article, a lot of bad news (based off mgmnts CC) is being discounted at these depressed levels..at minimum, the stock should be holding at 2 times cash value of $8.25; in addition, share buyback should be supportive...also, which heavy short interest, what else is there left to sell

2008 Jun 02 05:27 PM

[User 202507:]

Media processor company Sigma Designs (SIGM - $18.50) reported fiscal Q1 earnings on Thursday evening that came in below expectations on account of bloated inventory of IPTV set top boxes at one of its major customers. Management also admitted to slower than expected growth in Blu-ray DVD technology sales that will continue through the second half of this year as manufacturers were caught off-guard by the quick demise of the next-gen DVD format war (with HD-DVD) and - as is typical in DVD markets - vendors have begun aggressive pricing moves and expertise builds. The company expects to lose some market share as a result. Management also pulled guidance for the full year, which originally had been for revenue between $300 million and $350 million.

Revenue of $56.9 million actually was below the vastly reduced outlook for $60 million given at the end of fiscal Q4. Earnings were an adjusted $0.40 per share, down by half from the prior-year level. Reuters Estimates was showing a consensus average earnings target of $0.42 per share on $60.2 million in revenue.

Unfortunate, the miss is, but we remain relatively optimistic about the company's future, though we remain cognizant of the potentially significant compression in profits due to increased competition. Even so, the current single-digit multiples on forward earnings are a fair metric upon which to make an 'undervalued' assessment. Did cut our LG target price at $38

2008 Jun 02 05:44 PM

[Nom De Plum:]

Let's see....in just a few quarters the valuation metrics have gone from P/E multilpes, to Revenue Growth Rates, to Cash and Book Value...Has management publicly stated that they will not acquire another company? If not, most likely that acquisition will come at a higher revenue multiple and your precious 2x cash valuation gets pushed lower and lower....better hope managment has their shareholder hat on and not its engineer hat because with a bank account that full it's going to be tough for technology guys not to want to buy the latest and greatest.

2008 Jun 05 02:56 PM