ChipMOS Tech Bermuda: Company Is Undervalued

ChipMOS Tech Bermuda (NASDAQ:IMOS)

Recommendation: UNDERVALUED
Taiwanese semiconductor manufacturer with a depression valuation offers investors a strong upside with small downside risk. In terms of valuation alone, ChipMOS Tech Bermuda trades at a deep discount, all valuation methods confirm this thesis.

Investment Thesis:
ChipMOS Tech Bermuda seems to be undervalued due to a lack of investor familiarity, possibility of financial distress, a convoluted ownership structure, legal issues, and lack of diversification among customers. The following issues are reflected in the current price:

1.) Ownership: 50% of shares outstanding were owned by other semiconductor companies.
2.) Customer Concentration: 52% of revenues were generated by three customers in the previous year.
3.) Legal Issues: Shih-Jye Cheng, CEO, has been indicted by the Taiwanese Government for inappropriate use of company funds.
4.) Geo-political risk: ChipMOS operates in Taiwan with significant exposure in China. This exposes the company to significant political risk, given the less than friendly relations between Taiwan and China.

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Investors should find IMOS attractive because the company seems undervalued in terms of numerous valuation methodologies. The analysis below will illustrate ChipMOS Technology Bermuda’s value in terms of the following methods: free cash flow, take out value, relative valuation, earnings power value, and reproduction value. In order to provide a thorough valuation analysis, we will provide a comparison of IMOS to its competitors as well.

Table 1: Discounted Cash Flow Valuation for ChipMOS Technology Bermuda

The discounted cash flow valuation in table one supports our undervaluation theory. Returns on capital are well above the weighted average cost of capital resulting in a positive margin of 5.2%. Reinvestment rates are quite high, but this yields a very high growth rate of 38%. Unfortunately, the majority of IMOS’s value in this DCF is derived from the terminal value. Investors might find this problematic; nevertheless, the company still seems to offer investors a more than reasonable margin of safety. In other words, current values account for this issue.

Table 2: Valuation Data for ChipMOS Techology Bermuda

Comparing IMOS’s metrics to the Semiconductor Equipment Industry offers investors a compelling argument for investment. The chart above shows that IMOS seems to be worth at least $4 more than its current price. First, Price and Enterprise Value to EBITDA values are incredibly low, suggesting the company could be attractive to a “fabless” or other semiconductor manufacturing companies. The current value of IMOS from a relative perspective suggests investors believe that IMOS will encounter some sort of financial distress. Each valuation offers a significant margin of safety

Table 3: Relative Valuation of IMOS in Terms of Competitors

Table three compares IMOS to those companies it lists as competitors in its annual 20-F report. This comparison once again suggests that IMOS is undervalued and offers a significant margin of safety. Furthermore, the comparison suggests that investors might be well served in analyzing Advanced Semiconductor Engineering, Inc. (ASX) as well.

Business Prospects / model:
ChipMOS Technologies Bermuda is a holding company with investments in the following semiconductor businesses: ChipMOS Technologies Ltd. (Hong Kong); ChipMOS Technologies Inc. (Taiwan), which owns 35.6% of ThaiLin Semiconductor Corp. (Taiwan); and, Modern Mind Technology Limited, which owns 100% of ChipMOS Technologies Ltd. (Shanghai, PRC).

Table 4: Company Structure as Presented in 20-F Report

The company’s semiconductor holdings make IMOS an independent provider of semiconductor testing and assembly, meaning the company focuses on back end semiconductor manufacturing. They are a global leader in LCD and flat panel display testing and assembly, and a leader in the Taiwanese market for advanced memory products.

As of Monday, Mosel Vitelic, Silicon Precisionware, and Highbridge Holdings accounted for 51.5% of the shares outstanding. This seems to have been a drag on possible movements to the upside. In an interesting move, Mosel Vitelic lowered its position in IMOS by nearly 10% on Monday.

Mosel Vitelic, Inc. Sells Stake in IMOS

The interesting part of this story is that Mosel liquidated 10% of its position for $6.30 per share, for a total loss of $47.9M New Taiwanese Dollars. The sale should not have a dilutive effect, since ProMOS Technology, Inc. and Powertech Technology, Inc. each purchased Mosel's 10% position.

Special Circumstances:
Investors should pay special attention to page 25 of the annual 20-F report for IMOS. The annual report gives a comprehensive discussion of the trends in semiconductor manufacturing, which we will attempt to summarize / paraphrase now.

IMOS discusses the current trends in the semiconductor manufacturing industry and argues that these trends are responsible for company growth. Simply, the majority of semiconductor manufacturers have started to outsource the production, back-end services, of semiconductors. As semiconductor companies become “fabless” companies like IMOS receive more business.

They identify three key trends for this shift to outsourcing:
1.) Significant Capital Expenditure Requirement: complex structures and shorter product life spans makes it more economically efficient for semiconductor companies to outsource the fabrication and testing of semiconductors. Outsourcing allows the major companies to share the risks of a possible downturn in the industry
2.) Increasing Focus on Core Competencies: simply, the increasing expenses associated with fabrication makes forces companies to focus on design, while outsourcing fabrication.
3.) Time-to-Market Pressure: shorter product life spans force companies to outsource production

IMOS also provides an answer why these trends are pertinent to the company:

Outsourcing in Taiwan and China:
Taiwan is a leading global market for outsourcing of semiconductor fabrication and testing. Most companies focus on a specific part of the fabrication and testing process, resulting in economies of scale, higher utilization rates, and greater flexibility. Lastly, the proximity of China and Taiwan allows for greater economies of scale and quicker production times, since all companies are based in the same general geographic location.

I hold a 400 share position in ChipMOS Tech Bermuda, and in order to quell any conflict of interest concerns, here are a few articles that support our research:

Smart Money on IMOS

Motley Fool's Take on IMOS

Forbes on IMOS

Regardless of my views on ChipMOS Tech Bermuda, many media outlets seem to believe that the company is undervalued.

Disclaimer: The author cannot be held responsible for any monies gained or lost from trades undertaken based on information presented herein. The author currently owns the following stocks: 400 shares of IMOS at $6.90.; Agilent Technologies, Inc. (NYSE:A); Brasil Telecom S.A. (NYSE:BRP); ConocoPhillips (NYSE:COP), Biotel, Inc. (BTEL).

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Tagged: , Semiconductor Equipment & Materials, Taiwan
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