Shares of NamTai (NTE) have increased 48% since we recommended them in an article on August 27th. Our thesis was that the company had $3 per share of cash and no debt, a generous dividend, was trading just above book value, and best of all, was about to ramp iPhones, in addition to iPads. However, several worrisome datapoints have emerged, which cloud an otherwise exciting growth story. We are concerned guidance may be weaker than we previously anticipated when they report Monday pre-open.
We had expected NamTai to report revenues of $300-$340 million in 3Q, and to guide to $400-$500 million in 4Q - huge sequential and y/y improvements, with 4Q gross margins of 8%-9%, resulting in EPS of $0.32 to $0.38. This was based on 2+ million iPad and 1 million iPhone modules in 3Q, with a substantial additional ramp in 4Q - in line with management guidance from its 2Q conference call. Several datapoints now suggest our assumptions could prove optimistic. We still think $500 million quarterly revenue is achievable in 2013, although there is added uncertainty due to bankruptcy worries at Sharp.
The following 4 points are our key concerns:
1. iPad inventory correction - On its recent quarterly conference call, Apple (AAPL) noted that it sold only 14 million iPads during its September quarter, 3-4 million fewer than analysts anticipated. Apple also stated that there was excess iPad inventory in the channel. According to reports on Digitimes, Sharp had seen its iPad module demand drop from 900,000 units in July, to 400,000 in August. Assuming these are a fair representation of NamTai's business levels, a reasonable assumption since NamTai is Sharp's subcontractor for LCM assembly for iPads, unless September had a significant improvement, iPads could be below our expectations for September, and depending on sell-through, could have only slight growth in the December quarter.
2. iPhone manufacturing challenges persist - Apple indicated that the production challenges associated with iPhone manufacturing have yet to be fixed. NamTai had stated that it expected to do 2-4 million LCMs per month for a smartphone customer when ramped, and while it is possible they are at the high end of the range, we are inclined to take a more conservative estimate. Of course, at some point these problems will get solved and if NamTai indeed produces 4 million iPhone LCM monthly, revenues just from this program could be $100-$150 million monthly, $300-$450 million quarterly, just of iPhone assemblies.
3. CRUShed on margins - Cirrus Logic (CRUS) shares declined more than 11% yesterday, despite revenue, EPS results and guidance well ahead of street expectations. One major concern for investors was that gross margin declined, despite the higher sales, suggesting aggressive pricing demands from Apple. We are concerned that our previous 8-9% gross margin expectation could prove optimistic, and gross margins could come in 6-7%.
4. Sharp at risk of bankruptcy - Wednesday night multiple media reports quoted Sharp management acknowledging that the company had "going concern" risk. According to NamTai's 20-F annual filing, Sharp was NamTai's 3rd largest customer in 2011, representing 10.5% of revenue. We believe that Sharp was far larger in 2Q2012, perhaps 25% of sales or more, (NamTai does not provide quarterly reports) as NamTai was manufacturing LCMs for iPad for Sharp. Of course, if Sharp declares bankruptcy - which likely wouldn't be for several quarters - it's entirely possible Sharp could emerge stronger, and NamTai's business could continue uninterrupted, but without question, Sharp's ugly financial picture poses a real risk.
Uncertainty is the bottom line
If NamTai were back at $7.96, we'd likely be buyers. At $11.80, the stock isn't quite as cheap, and there is much more uncertainty than 90 days ago. As we look into 2013, barring a disaster with Sharp (i.e. Apple pulls all its business), this remains a company capable of doing $500 million in quarterly revenue, and $1.50+ in EPS. In addition, it is likely based on its history that NamTai ups its quarterly dividend from $0.07 to $0.10 or more, offering investors nice yield protection.
However, right now, there are simply a lot of unknowns - all could be fine, but a lot of datapoints suggest otherwise, at least short-term. And in times of uncertainty we act on Warren Buffett's adage "the first rule of investing is don't lose money; the second rule is don't forget Rule No. 1." We retain a small long position in NamTai, but have also purchased some out of the money puts as insurance.
At this point, we think there are better values out there. For example, if you think Apple's issues will eventually be worked through, as we do, why not simply buy Apple. At 10x EPS x-cash, and bad news baked in, we think its a bargain. We've also taken some of our NamTai profits, and added to our ChipMOS (IMOS) position. During the time since we wrote on NamTai, ChipMOS shares had fallen almost 30%, in large part due to a very positive development, misunderstood by the Street, which we explained in an article yesterday. Even after its 10% move yesterday, ChipMOS still offers a 35% free cash flow yield based on 2011, 2012 or projected 2013 FCF (each year is about $4). With a business levered to the growth of smart-phones and tablets, we think it offers a compelling risk-reward.
Additional disclosure: We conduct thorough research on our ideas, but our views are our own. Please do your own research. In addition to a long position on NTE, we also are long puts on NTE.