While last week's IPO market performance was disappointing in many respects, it was not a complete disaster. Both pricing discipline on the part of issuers and a healthy dose of caution on the part of IPO investors are critical to sustaining a healthy IPO market. On that note, we continue to believe the IPO market is in the early stages of its recovery, although there will be minor hiccups along the way. While last week might be viewed by some as a setback in terms of performance (only 2 out of 6 traded up in their market debuts) it was still the most active day for IPOs in two and a half years. Further, it demonstrated that risk appetite is there, but valuations still matter. The top performer of the lot, SPS Commerce (SPSC; up 13% on its first day), showed that investors are willing to reward select small cap companies with a track record of profitable growth.
Against this backdrop, two profitable and growing technology companies are on the IPO calendar this week: Convio (NASDAQ:CNVO), a provider of on-demand marketing software tailored for nonprofit organizations, and Alpha & Omega Semiconductor (NASDAQ:AOSL), a leading supplier of power management chips for laptops, flat panel displays and a variety of consumer electronic devices. While both stand to benefit from investors' craving for profitable growth, Alpha & Omega is the larger of the two and is could generate the most interest given its direct exposure to key pockets of the chip industry where demand is surging and supply remains constrained.
Detailing the IPO
Alpha & Omega plans to raise $91 million by selling 5.1 million shares at a range of $17-$19 per share. At the $18 midpoint, the company will command a market capitalization of $442 million and an enterprise value of $328 million (netting out post-IPO cash of $114 million). The company plans to list on the NASDAQ with pricing slated for Wednesday, April 28 after the market close. Deutsche Bank Securities (NYSE:DB), Piper Jaffray (NYSE:PJC), Thomas Weisel (TWPG) and Caris & Company are underwriting the offering.
Founded in 2000 by a trio of engineers from power chip company Siliconix, Alpha & Omega is a fast-growing supplier of chips that improve power efficiency and extend battery life in products such as notebook PCs, flat panel displays, mobile battery packs and digital cameras. The company has leveraged a strong design team, proprietary process and packaging technologies and a semi-fabless model (testing and packaging for many of its chips are done in-house) to produce chips with lower costs and greater performance than its competitors, which include larger chip companies such as Fairchild Semiconductor (FCS), International Rectifier (NYSE:IRF), On Semiconductor (ONNN) and STMicro (NYSE:STM).
Alpha & Omega's efficient, low cost chips have made significant headway in the market, as it has had success penetrating leading OEMs including ASUSTeK, Dell, HP and Samsung. It also has secured relationships with top Asian electronics manufacturers such as Compal and Foxconn. While laptop PCs are the company's largest end market, its products support a variety of devices in the consumer electronics, industrial and communications end markets. The company currently offers in excess 670 products, and has introduced over 100 products per year for each of the last three years, a testament to its strong development capabilities.
Riding out the semi-cycle
Alpha & Omega has significantly outgrown the market over the years, and it has proven that it can take share while profitably manage its business in an intensely competitive and cyclical industry. From 2005 to 2009, the company's revenues grew at a 24% CAGR, reaching $275 million for the 12 months ended December 31, 2009. Like all chip companies, sales dropped precipitously in late 2008 and early 2009 (Alpha's fiscal year June 2009 sales fell 25% to $185 million), but Alpha & Omega managed to generate positive overall cash flow throughout the downturn and results have since rebounded strongly.
For the six months ended December 31, 2009, sales grew by 40% to $139 million while adjusted net income rocketed 528% to $20 million. Momentum spilled over into the three months ended March 31, 2010, with revenue hitting $78 million (+21% sequentially and +187% year/year) and net income jumping to almost $10 million versus a year ago loss. While inventory re-stocking has benefited Alpha & Omega along with many of its peers, industry demand trends and outlooks provided by virtually all chip companies point to continued healthy unit growth, particularly for Alpha & Omega's key end markets such as laptops and flat panel displays.
Can power ICs super-charge this story?
Alpha & Omega's core products are discrete power chips known as power MOSFETs (metal-oxide-semiconductor field-effect transistors), which are devices used for basic switching and controlling of power in electronic devices. These solutions accounted for 87% of revenue in 2009. A few years back the company introduced a line of power ICs, a higher-end line of power chips used for more advanced applications. While only 13% of sales in 2009, these products are growing rapidly and, more importantly, carry profit margins at nearly 2x the level of its discrete power chips. Preliminary results for the quarter ended March 31, 2010 show power ICs reaching 15% of sales on growth of more than 200% over the prior year. While the bulk of Alpha & Omega's revenue will continue to be driven by its core general purpose power chips, a rising mix of power ICs could provide a boost to margins and earnings.
Intense competition and order volatility raise the risk profile
Unlike most chip companies, Alpha & Omega operates in an intensely competitive and cyclical market, which results in significant pricing pressure and extreme volatility in its results. While its highly-efficient, low cost chips have enabled it to profitably take market share, its mid 20% overall gross margins speak to the commoditized nature of its products compared to more differentiated, fabless chip suppliers, which can command gross margins as high as 60% or more. While Alpha & Omega's foray into the power IC space stands to benefit overall gross margins, with discrete power chips still driving the bulk of its business, overall margins are likely to stay below the 30% level for the foreseeable future.
Additionally, Alpha & Omega's historical quarterly results indicate the often sharp volatility in order trends within its end markets. Over the last six quarters, sequential revenue growth fluctuated between -44% and +117% (from a low of $27 million to a high of $78 million). While the unprecedented downturn in the chip industry and subsequent order rebound wreaked havoc on most chip suppliers, Alpha's relatively small size and low gross margin profile make its earnings particularly vulnerable to short term demand swings.
Chip stocks are surging, and Alpha is being priced to sell
Despite the aforementioned risks, Alpha & Omega appears to be coming to market at the right time in the cycle and at a discounted price. Semiconductor stocks have surged over the last 12 months in anticipation of rebounding orders, and recent results and forecasts have yet to disappoint. More than a dozen semiconductor companies have announced positive sales and earnings surprises for the calendar 1Q, and all have indicated that momentum is expected to continue into the 2Q.
Generally speaking, higher stock prices have keep pace with upward revisions in earnings, such that most leading chip stocks are trading at 15-18 calendar year 2010 earnings. Annualizing Alpha & Omega's most recent calendar 1Q results, it is being priced at roughly 10x earnings based on an $18 offer price. While chip companies offering more commoditized products typically trade below the industry average, Alpha & Omega's 10x multiple still appears cheap relative to both groups.
Setting this symbol in motion
Seven of the top 10 performing IPOs since March 1 can be characterized as technology-based companies, meaning that upcoming debuts from both Alpha & Omega and Convio stand a good chance of success. While both have their selling points, Alpha & Omega is a company that is coming to market at the right time and at the right price.
Recent trends suggest that the semiconductor upturn has yet to run its course, and Alpha & Omega's strong product development track record and low cost design expertise should enable it to continue to benefit from favorable demand trends among its blue chip customers. Further, there is attractive upside to its earnings should the company keep gaining traction with its higher margin power ICs. Even if IPO investors choose to discount its power IC opportunity, Alpha & Omega is still coming to market at a healthy discount to its peers, setting the stage for investors to flip the on switch for this IPO. There are also a number of earnings reports due out this week from major chip companies including Texas Instruments (NYSE:TXN), Broadcom (BRCM), Silicon Laboratories (NASDAQ:SLAB) and Taiwan Semi (TSMC); further positive surprises could provide a tailwind for Alpha & Omega's debut.