Trident Microsystems: Not a Rosy Picture

One of our readers asked about my thoughts on Trident Microsystems (Nasdaq: TRID). Trident is an electronics company that designs and manufactures integrated circuits for different digital media products such as digital television and liquid crystal displays.

I have looked at several electronics companies in the past and I have to say, the profit margins have been razor thin. Trident seems to be made from the same stuff, as their operating earnings over the past 7 years do not paint tranquil picture. During the past 7 years, Trident has had 4 years of negative operating earnings and 3 years where they had positive operating earnings. Their average operating margins over the last 7 years are negative and imply that if this trend continues they will lose value for shareholders. With the majority of their revenues coming from just 2 customers, I would classify their business model as very risky.

Another clue about lack of earnings is provided from the shareholder's equity section of the balance sheet. The bulk of the shareholders equity is in the form of additional paid in capital and very little retained earnings. Shareholders have been contributing capital for the common stock, but the company has not been earning much on this capital. It's possible that large dividends have been paid out to shareholders and that is why retained earnings are so low but I found this statement in the annual report:

"Our present policy is to retain earnings, if any, to finance future growth. We have never paid cash dividends and have no present intention to pay cash dividends."

There is approximately $200M in cash on the balance sheet. What is this cash doing except earning a poor rate of return? Trident doesn't need to accumulate this amount of cash (imho) to operate their business (there is almost no debt). This cash was essentially all contributed by shareholders since they paid $203M of additional paid in capital.

In addition to not wanting to pay out dividends to shareholders, Trident has massive quantities of stock options outstanding. There is approximately 16% of the entire shareholder float in the form of stock options outstanding. Why such an excessive dilution of shareholders interests? It's certainly not to reward stellar company profits.

So if you were thinking of investing in Trident, a few ways that shareholders might get paid is 1) through stock appreciation, 2) have a major shareholder get active in the company's affairs and change policies to be shareholder friendly or 3) another company wants to acquire Trident and shareholders can sell to the acquiring company.

Based on a free cash flow analysis, I don't see a rosy picture for Trident's future stock price. As well, there doesn't appear to be a strong white knight shareholder working to make reforms on shareholder policies. Lastly, this is not an ideal market for acquisitions. The financing for deals is getting a lot harder with the troubles in the financial sector. For the time being I would hold off on looking at TRID as an easy asset play.

Disclosure: No position

Comments

[Mauka:]

TRID has generated $150m+ in cash in the last 4 years. You took the time to write this entire article and with your expertise couldn't figure out where the Cash came from? Wow.

Look at statement of cashflows and you can see where the cash on their balance sheet comes from.

2008 Aug 08 12:13 PM

[Reyer:]

Hi Mauka,

My point on the article is that the cash on the balance sheet is approximately the same as the additional paid in capital but there is very little retained earnings. The implication of that statement, since Trident doesn't have a policy of issuing dividends is that Trident has not had much success generating net income over the years. I was not making a statement of where or how the cash got on the balance sheet.

I agree with you that Trident has been building up cash in the past 3-4 years but they have also tremendously increased stock option expenses in that period. If you look at the cash flows for 2005-2007, around $60M of the $115M of cash increase was assigned as stock option expenses (added back to net income on the CF statements since they are non cash expenses). Those options are fairly valued using Black Scholes with associated assumptions and $60M is a pretty decent bet as to the value of those options. These options are likely going to dilute shareholder interests and so you need to account for that in your valuation.

Lastly, I sincerely hope Trident can continue their good fortune but I value a company based on cash flows over an entire business cycle, not just the past 3-4 years. I want to include good and bad years in the valuation to be as realistic as possible. If you go back to the cash flow statements from 1997 to 2003, in those 7 years the total net cash flow impact was approximately -$12.5M.

I hope this clarifies my points.

-Reyer

2008 Aug 08 10:21 PM

[secmaven:]

The market has spoken. What used to be a twenty dollar stock is now trading under three bucks. Two customers. One goes bye bye and it is OOB for Trident.

2008 Aug 09 11:07 AM

[analysis_LOL:]

Reyer,
please don't give up your day job if this is the best analysis you can muster for a stock like TRID.

At around $3 TRID would probably be a good buy BUT current management clueless, so the competition is having some fun messing with TRID's business hopes to insure they bleed the maximum cash. Selling to a competitor would be a smart move, however refer to the statement "management is clueless"

If you want to write about a stock like TRID please at least understand the game that MTK is playing. TRID is just a puppet in this market Taiwans two big design houses, pull all the strings.

Analysis! LOL

2008 Aug 13 10:25 PM