Huawei's Top U.S. Suppliers: Parabellum

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Includes: ADI, AVGO, FLEX, FNSR, IIVI, IPHI, KN, LFUS, LITE, LSCC, MTSI, MU, MXIM, NPTN, OCLR, QRVO, STX, SWKS, TTMI
by: Kwan-Chen Ma
Summary

Huawei’s ban will immediately affect its top 19 U.S. suppliers’ $14 billion quarterly revenue from Huawei.

The ban, if instituted, will cost NeoPhotonics 49% of its revenue, Lumentum 18%, Qorvo 13%, and Micron 13%, just to name a few.

Such revenue losses will drop their stock prices somewhere between -5% and -50%. Since the ban, 15 of the 19 stocks already lost at least that much.

If the Huawei ban is like the ZTE ban, all 19 stocks look to recover their losses soon.

Hopefully, the above statement is not just a wishful thinking on my part.

As part of the "Tit for Tat" response to the ongoing trade war against China, the U.S. Commerce Department placed Huawei and 70 affiliates on an "Entity List" that bans U.S. suppliers from selling components or parts to the Chinese telecom without government approval. Additionally, President Trump signed an executive order that prohibits U.S. telecoms from buying foreign-made equipment that's deemed a risk to national security, laying the groundwork to effectively stop U.S. telecoms from using Huawei equipment on their networks. Obviously, U.S. companies that have large Huawei revenue exposure have taken a significant beating on the day of the announced ban (Figure 1).

While these two moves are designed to cripple Huawei's U.S. 5G operating activities, my interest is on how Huawei's U.S. suppliers would fare through this ordeal. Specifically, in this post, I aim to examine the stock price impact on the 19 most exposed Huawei's U.S. suppliers.

Figure 1: Top Five Huawei's U.S. Suppliers

Huawei's U.S. Suppliers' Revenue Exposure

Since the U.S. ban to sell telecom components works practically like the embargo, the revenue impact is both direct and immediate. As for the magnitude of the exposure, depending on the political interpretation of foreign-based companies and the risk they impose on national security, more than $14 billion of Huawei's U.S. suppliers' revenue can be at risk (Figure 2A). (Note: Huawei's annual Americas revenue is around $7.4 billion, while U.S. firms with more than 4% Huawei revenue exposure is about $14 billion in revenue). For this reason, I identified all 19 of Huawei's U.S. suppliers which have at least 4% of their revenue from Huawei. The data is obtained from Bloomberg's Supply Chain Database. Since the goal of this post is to estimate the impact on U.S. suppliers' stocks, each U.S. firm's revenue share (%), not the dollar amount, exposed to Huawei is the more important factor to their stock prices.

Accordingly, in Figure 2, the most Huawei-exposed U.S. suppliers with at least 4% revenue exposure are listed, including from high to low: NeoPhotonics (NPTN), Lumentum (LITE), Qorvo (QRVO), Inphi (IPHI), Micron Technology (MU), Oclaro (OCLR), II-VI (IIVI), Finisar (FNSR), Knowles (KN), Broadcom (AVGO), Skyworks Solutions (SWKS), Lattice Semiconductor (LSCC), Flex (FLEX), Analog Devices (ADI), Maxim Integrated Products (MXIM), Littelfuse (LFUS), MACOM (MTSI), TTM Technologies (TTMI), and Seagate Technology (STX). Note that the Huawei sourced revenue share ranking does not necessarily match with the Huawei revenue size ranking (Figure 2A), because each firm has a different total revenue.

I also want to point out the fact that most revenue exposed U.S. suppliers may not be relevant from Huawei's perspective, because it depends on the absolute revenue dollar amount, or cost of goods sold to Huawei. For example, the most revenue exposed U.S. supplier is NeoPhotonics with 49% of its revenue from Huawei (Figure 1), but it is only a 0.23% Huawei supplier (Figure 3).

From Revenue Losses to Stock Price Losses

The easy task is to identify the revenue exposure because it is on record. However, the more elusive one is to convert revenue changes to stock price changes. For that, I rely on a stock valuation model that relates company revenue to the stock price since it is U.S. supplier's revenue at stake. If a stock is valued based on its price to sales multiple, simple algebra will show that the percentage change in stock price, or stock return, can be approximated by the sum of the percentage change in revenue and the percentage change in the price to sales multiple:

% change stock price = % change in Sales + % change in P/S

Since the P/S multiple depends on future revenue growth, so the % change in P/S needs to be first estimated with the expected change in revenue growth. I will use Micron's case as an example to demonstrate the estimation process. In a previous post, for Micron's case, Figure 1 below illustrates a clear positively correlated relationship between P/S and revenue growth rate. Specifically, for every 1% change in revenue growth rate, it will reduce the P/S ratio by 0.4.

To show how to use the valuation model as outlined, for example, if a company's revenue growth is expected to increase by 10% and P/S will also increase by 4% as a result, the stock price will increase by 14% in total because of the revenue growth.

As Micron is expected to lose 13.00% for the loss of Huawei, adding the associated loss on P/S (-2.78%), Micron's stock is expected to decline by -15.78% (Table 1). Furthermore, Micron stock has lost about 13.33% since the wake of the ban (5/15), and there is a further downside -2.45% to come, per estimates.

Using the same procedure, the expected downside exposure of the 19 U.S. stocks from Huawei's ban is estimated in Table 1. From the largest, NPTN's -58%, to the smallest, TTMI's -5.35%, all stocks are expected to suffer from the ban significantly. However, at this point for all practical purposes, it is the remaining exposure that matters. The bad news is that the pain does not seem to be over yet for MXIM, FNSR, MTSI, and NPTN. On the other hand, for shareholders of FLEX, KN, LSCC, SWKS, AVGO, and TTMI, there are about 5-12% upside coming back to you.

By now, semi stockholders should have been used to the wrath of the trade disputes, as Huawei's ban may be the prelude of a long and expansive trade war. Investors start getting the sense that, just like terrorist attacks, trade wars may become a permanent part of the global commerce landscape. The message from this post should not be narrowly confined within the context of 19 named companies.

The bad news is that, at the end of the movie "John Wick: Chapter 3 - Parabellum," when John was asked, "John, Are you pissed?" John Wick replied, "Yes."

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.