Silicon Motion: What To Do When The Market Gets It Wrong

| About: Silicon Motion (SIMO)

Summary

Silicon Motion has a tendency to offer cautious guidance and routinely releases preliminary results for upcoming quarters.

On October 7th, the company released 2016 third-quarter preliminary results that will smash second-quarter projections. Silicon Motion's share price rallied.

But, the market pulled back this past week. Silicon Motion subsequently fell to bargain prices compared to its future projections.

Silicon Motion (NASDAQ:SIMO) is a fabless semiconductor company, which means it designs and sells semiconductors but outsources the actual fabrication or manufacturing of the chips. From 2009 to 2012, its two primary product lines were external (removable) storage controllers and LTE transceivers. In 2013, it transformed its business and product lines. Now, Silicon Motion's primary products are controllers for SSD (solid-state storage devices) and embedded memory.

For mobile storage, primarily smartphones and tablets, NAND flash memory is often used instead of a hard drive. It is lighter, uses less power and is suitable for sequential data storage (such as pictures and audio). NAND flash storage devices require controllers. An eMMC solution consists of the multi-media card [MMC], the flash memory and the flash memory controller. SSD (solid-state storage devices) controllers have replaced external storage controllers.

At the end of 2013, Silicon Motion claimed to support more NAND flash memory products with its eMMC controllers than any other company. In August of this year, it celebrated surpassing the mark of shipping five billion NAND flash controllers worldwide in just ten years. With its second-quarter earnings release in 2015, Silicon Motion predicted it would be "the world's largest merchant supplier of client SSD controllers" by the end of the year. Silicon Motion did not just gain market share in a static industry. It gained market share in an ever-changing and ever-growing industry.

The company explained its niche in bolstering NAND flash in 2014.

"Silicon Motion finds each generation of NAND flash to be weaker relative to endurance and data reliability. As the controller developer, it strives to bridge the loss with the constant requirements for fast performance at less expense. Therefore, Silicon Motion believes the total addressable market will continue to expand."

In the 2015 second quarter earnings call, the company explained how it masters that niche and gains its customer's confidence and loyalty.

"NAND flash makers continue to bring newer, more competitive but, increasingly, harder-to-manage NAND flash components to market every 9 to 12 months. We offer our partner a unique combination of - first: industry leading NAND flash management technology, second: this understanding of NAND flash necessary to identify sub-issues, and third: highly-customizable turnkey controller solutions."

The company expected its performance in 2016 to expand above the market growth rate, to grow at least 50%. The most evident proof that Silicon Motion continues to experience phenomenal expansion? It measures its quarterly performance based on sequential growth rather than year-over-year growth.

Silicon Motion Q3 Release

For six consecutive quarters, Silicon Motion had set a quarterly revenue record. When the company offered third quarter guidance in July, there was a slight possibility the record could fall. Revenue was expected to increase 0% to 5% sequentially. But for those willing to take a calculated risk, the odds were in their favor. Silicon Motion has a distinct tendency to offer cautious guidance.

For the full year of 2016, Silicon Motion's initial projections included a revenue increase of 12% to 20%. This set the range at $405 million to $434 million. Using the company's margin projections and historical performance, non-GAAP earnings per ADS would likely range from $2.31 to $2.70. After the release of first-quarter results, the company increased the full-year revenue growth projection to a range of 27% to 32%. Now, the revenue range equated to a range of $459 million to $477 million. Earnings per ADS would likely range from $2.69 to $2.79. Second-quarter results exceeded the company's original expectations. Once again, Silicon Motion updated full-year projections. Full-year revenue was expected to increase 44% to 46% over 2015. The revenue range now totaled $520 million to $528 million. Non-GAAP earnings for the full year should now range from $3.00 to $3.28.

2015 FY Revenue:

$361M

Revenue

Growth

Range

Projected

Revenue

Range

Non-GAAP

Earnings per ADS

Range

FY 2016 Original Projection

12% to 20%

$405M to $434M

$2.31 to $2.70

After Q1 Results

27% to 32%

$459M to $477M

$2.69 to $2.79

After Q2 Results

44% to 46%

$520M to $528M

$3.00 to $3.28

Source: Author-created from company data

Second-quarter revenue totaled $140.7 million. For the third quarter, Silicon Motion offered this guidance with its second-quarter results.

  • Revenue to increase 0% to 5% sequentially

  • Gross margin (non-GAAP) to be in the 46% to 48% range

  • Operating margin (non-GAAP) to be in the 26% to 28% range

The company also shared its expected seasonal weakness in the fourth quarter.

At the end of the first half of 2016, Silicon Motion was on track to deliver full-year revenue of $534.8 million if the third and fourth quarters delivered revenue equal to the second quarter. Likewise, if the non-GAAP earnings per ADS performance in the second quarter simply repeated in the third and fourth quarters, the full year's total would be $3.26.

Besides its tendency to offer cautious guidance, Silicon Motion is also prone to sharing preliminary results each quarter. Third-quarter results are due out October 27th. Preliminary results were published October 7th. The news was smashing.

Silicon Motion now expects sequential revenue growth in the third quarter in a range of 11-13%. So, instead of the quarter's revenue increasing to a range of $140.7 million to $147.7 million, it will increase to a range of $156.2 million to $159 million. Revenue through the first three quarters of 2016 will now range from $409.6 million to $412.4 million. The company will have achieved in three quarters what it first expected to achieve in the full year.

In the preliminary results release, Silicon Motion also shared its non-GAAP gross margin was expected to be in the range of 48% to 49%. In the second quarter, it had projected the margin would fall in a range of 46% to 48%. Through the first half of 2016, non-GAAP earnings per ADS totaled $1.54. Extrapolating earnings for the third quarter leads to a range of $0.90 to $0.92. Through three quarters in 2016, the company should be tallying non-GAAP earnings per ADS in a range of $2.44 to $2.46. Just as with its original revenue projection, Silicon Motion's non-GAAP earnings per ADS will register in three quarters what it had originally projected to register for the full year.

The market was impressed. Silicon Motion's share price jumped to $55.00, just over 2% shy of its 52-week high of $56.25.

But, this past week saw an overall market pullback. Silicon Motion followed suit. On October 13th, the company's shares sold off dramatically and dropped nearly 7%.

It cannot be ignored Silicon Motion was expecting seasonal weakness in the fourth quarter. Yet, even if revenue stalls and falls to second-quarter levels, full-year revenue should tally to a range of $550 million to $553 million. Non-GAAP earnings per ADS should narrow to a range of $3.18 to $3.20.

From 2010 to 2015, Silicon Motion's compound annual growth rate (CAGR) for revenue is an impressive 22%. For earnings per ADS, the CAGR in the same time frame is a staggering 38%. For 2016, year-over-year revenue growth should reach at least 52% and non-GAAP earnings per ADS growth should reach at least 83%.

Silicon Motion continues to innovate. In early August, the company introduced an array of five controller solutions using 3D NAND. As a natural consequence of its innovation, it projects strong growth in 2017.

  • Client SSD controllers should grow at least in line with market growth at 20% to 25%.

  • eMMC controllers should grow at least in line with market growth for smartphones at 5%.

  • Industrial and enterprise SSDs are expected to grow by 15% to 20% (with China growing a bit faster).

Perhaps the most telling evidence of growth are Silicon Motion's want ads. Despite hiring in both the first and second quarters, the company still had openings and unmet demand.

"We remain resource constrained. And, we are still trying to invest and hire people to address all the additional projects that are partners want us to take."

Using the market's historical average of 15, the company's shares should be valued at least in the $48 range based on current year estimates. However, the market is typically forward-looking. Furthermore, Silicon Motion certainly warrants a multiple greater than the market's historical average. If non-GAAP earnings per ADS increased only one-third its five-year CAGR in 2017 and were granted a multiple of 18, fair value jumps to the $65 range.

With little doubt, last week's pullback in Silicon Motion's share price was unwarranted. It offers alert investors opportunity to build or strengthen a position in the company at what are now bargain prices. When official results are released on October 27th, the market will likely correct its course. Just seven market days remain to move on Silicon Motion.

Disclosure: I am/we are long SIMO.

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 belong to an investment club that owns shares in SIMO.

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