At one point in its history, MIPS Technologies (MIPS) was a leader in CPU development, but it has been more or less forgotten about today. In the early days of the computing revolution, it gained fame as supplier of the chips that powered Silicon Graphics' (SGI) mighty workstations and servers. In the ensuing years, SGI's fortunes came to a screeching halt, forcing it into bankruptcy - Rackable purchased what remained of SGI and also assumed SGI's brand and image. During that period of strife, SGI converted its product lines from being powered by MIPS' processors to using Intel's (INTC) chips instead. Following the loss of its marquee customer, MIPS has mostly concentrated on developing processors for the embedded market.
MIPS is a fabless CPU designer, meaning that while it designs processors for various applications, rather than owning and operating incredibly expensive production facilities that competitors such as Intel are famous for, it relies upon its customers to produce the actual chips. This is the same model long followed by ARM Holdings (ARMH), the company with the most name recognition in that space.
Though it lacks customers with the visibility of SGI, MIPS' CPU's can be found all around us; they power Blu-Ray players, set-top boxes, televisions, network adapters, WiFi routers, and even low-end Android tablets.
On the business side of things, MIPS sports a very healthy balance sheet, with assets composed of:
- $110 million of cash and short term investments,
- $27 million of receivables, and
- $18 of other assets (property, intangibles, etc)
On the other side of the column, it has only:
- $14.5 million of accounts payable, and
- $11 million of current and long term liabilities
Each year over the last three years, MIPS has added $12 to $17 million to its pile of cash and investments. With over 125 licensees and 500 million chips produced each year based on their designs, it has a widely diversified revenue stream.
At today's closing price of $7.20 per share, MIPS has a market capitalization of $387 million and trades at a lofty 27 times earnings.
However, I must point out that those factors alone wouldn't merit MIPS a place in my portfolio.
Here's where it gets interesting.
I consider myself to be a value-oriented investor and on top of that, I put a strong emphasis on owning companies who generate cash flow for their shareholder-owners. With a P/E of over 27 and no dividends being paid, MIPS is not the type of company that I'd generally want to own.
In order to scratching below the surface, I backed out the current assets and liabilities, and saw that MIPS actually trades at an earnings ratio of just over 18, still high by my book, but not nearly as lofty as the earnings ratio of 27 that is reported on all of the financial websites.
That alone still didn't generate too much excitement on my behalf, but I found that in April, Bloomberg reported that MIPS had enlisted Goldman Sachs to help it find a buyer. Since then, rumors have been swirling about possible candidates.
I believe that MIPS will eventually be acquired - it's a compelling target due to both its ongoing business and its patent portfolio. Who the acquirer ultimately ends up being is not much interest to me. Nor do I have a guess as to what the acquisition price with be. I'm actually not at all concerned with what the price is that it eventually sells for. MIPS is a profitable, healthy company - it can afford to wait for the offer it wants rather than be forced to accept any low-ball offer that comes its way.
On September 5th, I purchased my first shares of MIPS at $7.06 and simultaneously sold an October 19 call at a strike price of $7 for 65 cents. Supposing that MIPS is priced above $7 per share on October 19th, the shares I bought at $7.06 will be sold for $7 each, to which I will have also pocketed 65 cents of option premium. That's a 9% return for holding the position for 45 days.
The main risk I foresee is if MIPS announces that it has decided that it has no intention of seeking a buyer. If that turned out to be the case, all of the people who are currently holding in anticipation of a merger or acquisition announcement might jump ship. In that case, the value of the shares would decline, albeit with an adjusted cost basis of $6.40 per share, I would be somewhat insulated from losses.
I consider that risk to be an outlier, however. I feel that if it was a rumor that should be nipped in the bud, MIPS' management and/or Board of Directors would have done so already.
The other risk of the transaction is that a buyer is found, and that the buyer is willing to pay more that $7.65 cents per share, as that is the cap on what I can receive from this transaction. I consider a 9% gain over 45 days to be a successful transaction on its own, so I'm not concerned with this "risk" of leaving money on the table.
Supposing that the share price is still above $7 at the close of trading on October 19, my shares will be called away. That, or I may simply buy the options back. If that is the case, the transaction will have been a successful and profitable one.
If the share price has fallen below $6.41, there will be a paper loss. The opportunity will still exist to sell additional calls against those shares, further lowering the basis, and increasing the likelihood for profit.
If the investment landscape is the same on October 22 as its is today, especially if MIPS options still command such a high price as they have over the last month, I will likely enter into an identical transaction by selling November or December calls against either newly acquired shares or the shares I own (if I buy back the option).
As a value investor, as the market has marched higher and higher, I've been watching my universe of investable companies. There are positions in my portfolio that I would love to add to, if only the shares weren't expensive. This transaction represents a new strategy for me - in coming to an understanding and executing upon it, I am greatly expanding my own universe of investment opportunities.Disclosure:
I am long MIPS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional Disclosure: I am long MIPS and short Oct 19 MIPS $7 Calls. This article is not investment advice - anyone considering mimicking this position or conducting a similar transaction should do their own due diligence and evaluate their goals, risk tolerance and all that other fun stuff.