Blueprint For A Possible Double In Neonode

| About: Neonode, Inc. (NEON)
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Over the past few years there have been a few notable up-listings of exciting growth companies from the bulletin board to the Nasdaq. In particular, Interclick (purchased last year by Yahoo) and ZAGG Inc. (NASDAQ:ZAGG) come to mind. While their respective moves were not perfectly linear, both stocks ultimately delivered 100%-200% returns to those investors who took a position in them immediately after they were up-listed to the Nasdaq.

This leads us to Neonode Inc. (NASDAQ:NEON), a touch-screen solutions provider whose shares began trading on the Nasdaq on Tuesday, May 1st. While relatively unknown to most investors, we feel Neonode will quickly be embraced by institutions now eligible to buy shares on the Nasdaq. With just under 31 million shares outstanding and a licensing revenue model churning out 90% gross margins poised to scale in the second half of this year and 2013, Neonode's shares now seem ready to double over the next 12-18 months. Let's dig deeper to see why we feel this way.

Before examining Neonode's current business prospects, it behooves us to understand where the company has come from over the past seven years. In early 2007, Neonode released the Neonode N1, perhaps the first smartphone in which the idea of touch control stylus by finger was introduced. A special interface called "Neno" was developed for this phone, which supported the control technology using the thumb. With only two models produced the phones never gained traction, causing the company to retreat, regroup and plan out the next phase of its business development.

This leads us to the past 18 months. During this time, the company has transitioned itself to a licensing revenue model for its next-generation touch technology called Z-Force. Z-Force offers high-performance, multitouch capability that is competitive with leading capacitive solutions, at a less expensive price point, on par with older resistive technology. Other advantages of Neonode's technology include low power consumption, 100% optical transparency, and a high manufacturing yield. Z-Force has already gained significant share within the e-reader market. 2011 wins include Amazon (NASDAQ:AMZN), Barnes and Noble (NYSE:BKS), Kobo, and Sony (NYSE:SNE).

Looking to broaden the range of applications for its technology, Neonode recently released its new multisensing technology. Developed to help OEMs and device manufacturers separate themselves from the competition, the multisensing technology addresses a number of new verticals for Neonode. These include smartphones, tablets, touch displays for the office equipment market, and consoles for the automotive market. As a testament to how quickly Neonode has begun to gain traction in these new verticals, just last week the company announced it they had secured a total of 17 new design wins in the first quarter. According to the Cowen analyst, most of these new design wins are outside of the e-reader segment and are based on color displays. These new licenses lend support to the back half of the year, when the company appears ready to finally have its breakout quarter.

After reporting $6 million in revenues in 2011, Cowen is currently estimating the company will earn $0.13 a share in 2013 on a tripling in revenues to $19 million. The third quarter is when business should really ramp, with current revenue expectations of $6.3 million, with earnings of $0.07. In Q4, Cowen expects Neonode to benefit from strong seasonality and a ramp in new products, booking revenues of $8.3 million and earnings of $0.11.

After languishing on the bulletin board for years, Neonode's shares will now benefit from new and significant money flows into the name starting this week. Based on the recent strength in the stock, it seems as though this process has already begun to unfold. In a market devoid of secular growth, Neonode's shares will be attractive for a number of reasons. First, everything is moving toward touch. Whether it is your iPhone, Android device, tablet, or car console, chances are good that touch technology will soon play a major role in these offerings. Neonode offers institutional investors a pure play on this secular trend. With its very high gross margins, it is on its way to becoming a very profitable company that will generate significant cash flows for its investors. 2013 estimates call for the company to double revenues to $43 million. Earnings are expected to triple to $0.42.

It would not seem unreasonable for this new set of investors to propel shares to the $7-$8 zone by the fall. Such a move would value shares at 20 times forward 2013 numbers, a valuation that seems very accommodative for a company on a path to tripling its earnings next year.

A move to these levels would then most likely be followed by a period in which the stock bases out. For the stock to double by early next year, we would need to see a new set of institutional buyers come into the name. It would not surprise us to see the company do another secondary of 3-4 million shares at this time. With less than 31 million shares outstanding, such a move could serve two purposes: One, it would bolster the company's balance sheet to over $30 million in cash. This would allow the company to attract Fortune 500 companies that like to see at least $30 million in cash on a technology supplier's balance sheet. Two, a secondary would improve the liquidity in the name, a big draw for the likes of Fidelity and other large mutual funds that want to own 500,000 to 1 million shares of a growth name like Neonode.

An enhanced balance sheet could also allow the company to get more aggressive with its patent portfolio. Neonode currently has been issued three patents in the U.S., one of which covers a version of slide-to-unlock that was previously mentioned by Samsung in a case vs. Apple. While we are currently not denoting any specific value to Neonode's IP, it would not surprise us for some investors to eventually add in a layer of IP value to the shares in the future.

Looking ahead to 2013, if Neonode's management can deliver on current estimates for 2012, we expect a new set of institutional investors to eventually drive the stock into the double digits. Many institutional investors will wait for a few quarters of execution before taking positions in the stock. Assuming that Neonode's management team can deliver, we feel that these new investors will gladly pay up for a more liquid stock and a company on the cusp of a major secular trend within the technology space. This new set of buying should ultimately lift the stock to our price target of $10, a double from the stock's current price of $5.

As with all investments, purchasing micro-caps should only be undertaken by those investors with a high tolerance of risk. Insiders have also sold big blocks of stock over the past number of months. We consider this a red flag, but one that will eventually recede into the background as the company begins to scale its business in the second half of the year. Other risks investors should consider include possible pricing pressure on Neonode's products, its ability to properly penetrate new verticals, and technology obsolescence.

Disclosure: We are currently long NEON.