GSIT is a cash rich technology company with a long history of profitable operations (35+ quarters of profits). After winning an ITC Lawsuit against Cypress Semiconductor (CY), the business is on the cusp of picking up a huge amount of market share which could double their revenues. Additionally they have a second product line about to start generating revenue. The management team owns 24%+ of the stock and have proven to be good stewards of shareholder capital. Within 24 months, the company could earn $40mm of EBIT and over $0.90 per share. It is currently trading at 5.6x EV/EBIT, however given the growth potential, it is trading at only 2x EV/FY2 EBIT.
A 10x EBIT valuation (hardly expensive) would put business worth $17 per share today.
- Stock Price: $5.50
- Shares Out: 27.5mm
- Market Cap: $152mm
- Book Value / share: $4.76 (1.16x)
- Cash Balance: $93.2mm
- Enterprise Value: $58.1mm
- Revenue /// EBIT (LTM): $71.5mm // $3.0mm
- Legal Expenses : $7.43mm
- EBIT ex legal expenses : $10.44mm (15% margin)
- Invested Capital*: $52mm
- ROIC **: 19.5% (35% average since 2007)
- Insider Ownership %: 24% = 6.5mm shares
- Current Valuation: 5.6x EV/EBIT
*(Invested Capital = Total Equity + Total Liabilities - Current Liabilities + Short Term Debt - Excess Cash)
**(ROIC = EBIT-ex legal ltm / Average Invested Capital ltm)
SRAM is different than DRAM.
- The core markets for SRAMs are Networking & Telecommunication Equipment, Military applications, and some Industrial applications.
- SRAM is a high mix, low volume product category. DRAM is the opposite…low mix, high volume. This means that SRAM doesn't have the huge production builds and wild price swings that plagues the DRAM industry. These are not consumer products. The ASP curves are very predictable. Product cycles are long at 5-6+ years. For example, GSIT started getting Cisco business in 1998 and they are still shipping parts from designs 11 years ago.
- The majority of sockets in the industry are dual sourced. However, some sockets on the bleeding edge are sole sourced. GSIT has 120 parts with Cisco, there are 10 that are sole sourced and 7 where no one else could even do it.
We estimate TAM for SRAM market to be $850mm+
- Market share estimates
- GSIT has ~10% market share.
- ISSI is traditionally strong in automotive and industrial, not so much in telecom/networking.
- Samsung has announced they are exiting the business. (More on that later).
- GSIT has been under pressure for over a year due primarily to an ITC lawsuit against it from their main competitor Cypress Semiconductor. Cypress also launched a bit of a smear campaign against GSIT. Cypress's CEO had made bombastic comments on earnings calls and at conferences about how they would win this case, likely scaring away shareholders as well as customers. GSIT's revenues lagged over the last few quarters, likely illustrating this tactic had some success.
The truth will set you free….
- However, the truth of the matter came out on October 25th,when ALJ Charles Bullock issued his Initial Determination ruling in favor of GSIT, citing no infringement on their part. This is a major coup for GSIT and the stock immediately reacted to the news, however I think the market does not yet fully appreciate the magnitude of this news.
The opportunity -- market share + new products = 150% growth.
- By removing this overhang on the company, GSIT is in a wonderful position to more than double the business through market share gains. The 2nd largest player in the market (Samsung) had announced months ago they would exit the market at the end of this calendar year. This creates a jump ball on 15% to 25% of the TAM (roughly $150-$250mm in revenue).For comparison's sake, GSIT generated slightly less than $80mm of revenues over the last twelve months.
- While it is likely to take between 12-18 months before the market share gains start to reflect in revenues, we think GSIT is in the best position to gain share. The reality is that there is a ceiling on how much of a market any one company will be able to control, and CY at 40% is very close to that ceiling today. It should be obvious Cypress is in more sockets than GSIT today, and thus share more sockets with Samsung than GSIT would share with Samsung. Thus, when customers look to add a second source to replace Samsung, it is more likely they turn to GSIT than to CY to be that second source.
- We think GSIT will be able to double their market share through picking up its fair share of the Samsung business.
- The reason this market share gain will take time is Samsung will likely continue shipping through the 2nd quarter of CY13, and it is possible that customers have struck deals with distributors to take on a lot of inventory. However, the fact is that there is an end to that inventory, and GSIT will be a prime beneficiary once the inventory is cleared.
- We think this alone makes GSIT a compelling investment, but there are a few more legs to the stool. GSIT is in the final stages of launching a new product line, LLDRAM (or RLDRAM), which is a hybrid of SRAM and DRAM. Today there is only one supplier, Micron (MU), and customers have clamored for a second source. (It is one of the highest gross margin products for Micron today.) GSIT believes that within 12-18 months, this product line could generate $10mm revenues per quarter ($40mm per year) at comparable gross margins to company average. If they achieve this, it would be 50% growth over their current run rate revenues.
- Finally, the telecommunications equipment market has been soft and that has filtered down to SRAM suppliers. When spending picks up again, they will benefit from an additional tailwind.
- When you combine these factors, we think that within 18-24 months, the company could be generating nearly $40-50mm in revenues per quarter. The company has very low overheads and as the revenue scales, they should be able to gain some operating leverage on R&D and SG&A to generate EBIT margins at the 25%+ level. On a yearly basis this would be nearly $45mm of EBIT.
- The company has an Enterprise Value of $61mm. I know of no cheaper stock in the market today. It is trading at 1.4x EV/EBIT FY2!
Bull case scenario.
- FY2 -- looking out two fiscal years
- $175mm revenue
- $40mm from LLDRAM
- $55mm increase in SRAM.
- 70% growth in SRAM from market share increases over 2 years. (This is slightly lower than what the company has expected.)
- Some modest end market growth.
- 25% EBIT margin
- $44mm EBIT
- 10x EBIT = $440mm
- + $90mm cash today
- + $30mm cash flow
- = $560mm / 28mm shares = $20.00
- Discounted back to today @ 11% = $17.00
- Buyback - Company has in place a $10mm buyback, executing through a 10b-51 plan which allows them to purchase stock during periods normally blacked out.
- Potential for acquisitions. The company has commented, (paraphrasing) "We will look to add one more product that is still within our core competency. We want something with higher IP, higher margin, but serve the same customer. We'd look to a private company that is too small for a customer to consider their technology but would consider it if we owned it. We want to move beyond being perceived as a memory company and become more of a telecommunication service provider. If the right deal came along next quarter, we'd do it."
- Our view on this is that any deal would likely be small relative to the size of the company. We think the management team has proven themselves to be skillful allocators of capital and will give them the benefit of the doubt on any "product" acquisitions that cost less than $20mm to acquire.
Some Risks To Keep In Mind:
- CY has requested a full review by the ITC Commission on the Initial Determination. ALJ Bullock is the senior judge at the ITC, so we find it unlikely that the commission will overturn his judgment.
- CY had originally filed a patent infringement case in District Court, however, the odds are quite low that a District Court would rule differently than the ITC in a case like this.
- Customer Concentration - GSIT generated 40%+ of revenues from Cisco. All indications are they have a very strong relationship with Cisco. CY actually sued Cisco as part of the case against GSIT. GSIT paid for all the legal expenses to defend itself and its customers.
- Military market is volatile and lumpy.
- Further slowdown in the economy. This will put some pressure on revenues, however, the market share gains will still happen over time. The longer it takes for Samsung inventory to clear the longer it will take for market share gains to be reflected in GSIT's revenues.
- GSIT is unable to get the largest LLDRAM customer to qualify its product.
- MOSY gains traction and starts to penetrate the SRAM market - see this as a low risk, but worth keeping in mind.
- ITC ruling is overturned.
- Company's products are faced with an injunction.
- Lose all of affected revenue. Potential = $17mm = 20% of revenues.
- Grow from that lower base = $75mm
- $20mm from LLDRAM (lower than expectations)
- $8mm increase in SRAM.
- 10% growth from market & market share over 2 years.
- Total revs = $103mm
- EBIT margin 18% = $18mm
- Pay $20mm in damages to CY related to civil case. (This is a wild guess).
- 5x EBIT
- + 69mm cash
- + 15mm cash flow
- = $176mm / 29mm shares = $6.00
- Discount back to today = $5.00
- * Note: The stock would likely fall further below this price if they lose the case. I would view that decline to be temporary in nature, assuming these assumptions are accurate.
GSIT is a cash rich technology company with a long history of profitable operations (35+ quarters of profits). After winning an ITC Lawsuit against Cypress Semiconductor, the business has an opportunity to more than double the business through market share gains. Additionally the LLDRAM product could add another $40mm in revenues per year within 18 months. The management team owns 24%+ of the stock and have proven to be good stewards of shareholder capital.
Within 24 months, the company could earn $40mm of EBIT and over $0.90 per share. It is currently trading at 5.6x EV/EBIT, which is already cheap. If the estimates prove accurate, it is trading at only 2x EV/FY2 EBIT.
A 10x EBIT valuation (hardly expensive) would put business worth $17 per share today, representing more than 300% upside.
Additional disclosure: This is not a recommendation to buy or sell (short) any security. This article is for information purposes only and represents my personal view and does not necessarily represent the view of my firm. Please do your own work and come up with your own conclusion. My firm has a capital position in GSIT. At the same time we may or may not trade in and out of the stock and take no responsibility to update anyone regarding our investment position and/or view.