Since its IPO four years ago, MTSI has been methodically promoted as a growth business with "huge" opportunities. However, a thorough analysis of the operating model, financial results, and overall "growth story" reveals a very different picture marked by M&A that hides weak organic growth, intense hype, accounting alterations & shenanigans, and material misrepresentations.
Cold Shower Analytics' entire, 70-page report on MTSI can be found here:
Fair Value < $21.08
Downside ~ 39%
We believe M/A-COM's charade of deceit began with a smoke and mirrors based IPO in 2012. With the help of its bankers and loyal sell-side analysts, MTSI was positioned as a turnaround with its re-energized new product pipeline driving organic growth acceleration. Through the subsequent years of failed promises and organic revenue declines, MTSI has relied on acquisitions to create the illusion of growth, while management has blatantly claimed acquired revenue as organic to "boost" reported results. We believe the Company's liberal revenue recognition changes and "creative" Non-GAAP accounting that may appear straightforward on the surface, are blatant violations of SEC Regulation G and warrant an immediate SEC investigation. We also document material alterations to past quarter Non-GAAP presentations and pro-forma accounting treatments that vary quarter-to-quarter.
Never shy about using forward-looking statements under the auspices of Safe Harbor language, we believe MTSI management has grossly misrepresented past results in its investor commentary. As we illustrate, SEC filings and investor materials have repeatedly diverged from management's verbal commentary. MTSI has repeatedly winked and nodded about business opportunities measured in billions of dollars, all of which are always at the cusp of inflection or already ramping. Our analysis documents how none of these past stories have materialized in a tangible manner or have stemmed the secular decline in its core business.
The latest growth story is premised on three product areas, each supposedly capable of doubling MTSI revenue in 3 - 5 years. However, unsettling discoveries from reputable sources, such as reports to Congress and documents from the FCC, NOAA and FAA, make it clear to us that two of these so-called opportunities (GaN and Active Antennas) are essentially R&D initiatives that are 5 - 10 years away from meaningful adoption (if they ever happen at all). The third story, datacenter 100G, is still in the concept stage and requires drastic cost reductions before meeting necessary price points. Despite the emerging holes in its story, MTSI management continues to set a lofty goal of 30% revenue CAGR, which stands in stark contrast to the Company's negative 6% organic revenue CAGR over the past four fiscal years.
There are four factors that have driven MTSI's severe dislocation from economic reality. First, prior to its IPO, MTSI was 66% owned by its Chairman and majority holder John Ocampo. While concentrated ownership is often aligned with shareholder interests, Mr. Ocampo's incessant selling may suggest his incentives to "go the extra mile" to maximize valuation may have blurred the line with accurate messaging. Second, MTSI was a hodge-podge of unexciting microwave components in secular decline (Ford's SYNCTM system was the growth component), which meant management required a "Cinderella's story." Third, MTSI's leadership included a first time CEO. As a result, we have not found the typical conservative and transparent approach to investor communication. Instead, we believe Mr. Croteau has played fast-and-loose with numbers, while grossly underestimating the risks of misrepresentations and projections that are decoupled from reality. Fourth, MTSI has perpetuated the charade and illusion of growth through significant acquisitions in December in each of the last three years. To wit, MTSI has become an investment banker's dream, which we would surmise may be a contributor to the lenient analysis and favorable ratings espoused by the sellside. While the carrot of future growth "opportunities" has been consistently dangled to investors, insiders have unloaded hundreds of millions of dollars' of shares.
The "borrow-acquire-grow and make promises about the future" game fails to work once investors lose confidence. With the analysis herein, the toothpaste will be out of the bottle. In our opinion, as that occurs, management will be hard pressed to explain the voluminous unhedged and irresponsible promises from past conference calls. Based on the rampant insider selling, this could present a major problem for management based on questionable revenue recognition changes and other deceptive tactics. When the dust settles, investors will see MTSI for what it is: a business that has organically missed the original fiscal year estimates by a staggering $32 million the last four years, representing a 7.8% average annual shortfall. As the truth emerges, we expect the business to be valued for what it is - a debt-burdened, no-growth company in need of a hard expectation reset and a proper turnaround under a different management team.
THE FIVE OVERARCHING SEGMENTS COVERED HEREIN
I. Exposing MTSI Management For Abusing Investor Trust with Smoke & Mirrors
II. Exposing MTSI Management's Accounting & Reporting Shenanigans
· In its F1Q15 (C4Q14) results, MTSI had a $15.1 million revenue and $0.18 EPS benefit from changing revenue recognition from sell-thru to sell-in. This was not communicated when the Company provided guidance in November 2014. If this effect had been disclosed at the time of guidance, the implied organic guidance would have been 11% - 14% and 45% - 55% below the prevailing consensus revenue and EPS estimates, respectively. This would have very likely resulted in a massive disappointment and significant stock price decline. The CEO's prepared comments did not acknowledge the accounting change and the CFO's comments failed to specifically state whether the accounting change was included in guidance. It stands to reason that the 51% advance in MTSI's share price from the November earnings call to the January earnings release was primarily driven by the deceptive accounting changes. We would note that Mr. Ocampo sold $11.8 million worth of shares during this period in open-market sales. The accounting shenanigans continued into the next quarter with a $3.7 million one-time benefit from a deferred revenue recognition "windfall." Without this benefit, MTSI's actual results would have missed the midpoint of guidance and been $3 million below consensus estimates for F2Q15. Instead, due to a one-time revenue benefit, MTSI "beat" by $1 million.
· In F1Q16 (C4Q15), MTSI once again pushed the boundaries of accounting interpretations into an area we believe violates SEC guidelines. After previously excluding the impact from discontinued operations, MTSI's Non-GAAP Net Income calculation was inexplicably altered to no longer exclude Income from Discontinued Operations (the divested Automotive business). This calculation change to Non-GAAP Net Income added $1.2 million, which resulted in a 6% overstatement compared to its prior definition. Combined with the fact MTSI's headline Non-GAAP EPS of $0.40 also included $0.5 million from acquisitions done during the quarter (i.e. not part of original guidance), the "true" EPS of $0.37 was at the low end of guidance and below consensus estimates. The unexplained inclusion of previously excluded Income from Discontinued Operations appears to be a blatant violation of the Non-GAAP disclosure requirement of SEC Regulation G.
· After including discontinued operations in F1Q16, MTSI retrospectively altered the presentation in its subsequent earnings release for F2Q16 to exclude Income from Discontinued Operations. Incredibly, the Company chose to add back the income from Consulting Agreements related to the discontinued and divested Automotive business. This is a direct violation of MTSI's own accounting policy as outlined in its 10-K that Consulting Agreement income is included in Discontinued Operations. The net result of MTSI's altered treatment of Consulting Agreements, which were previously discontinued operations, results in an artificial $1.875 million quarterly boost to Non-GAAP Net Income. We believe this is a clear violation of SEC Regulation G and warrants an investigation by the SEC and MTSI's Board (unlikely considering its Chairman).
· Mr. Croteau has made many misleading statements, yet two warrant material scrutiny. First, perhaps in the spirit of focusing hype on the core business and deemphasizing the Automotive business, he encouraged analysts to model low-20% operating margins for Automotive revenue. The obvious result, in hindsight, was that the investment community overestimated the profitability of the core business. After MTSI announced it would divest this business, public filings revealed that the Automotive business had delivered 31.5% operating margins in FY2014 and 30.5% in the first three quarters of FY2015. While it is impossible to know whether the misleading margin insinuations were a function of ethics or incompetence, we believe the Ford business had limited life in sole-sourced status and MTSI attempted to soften the eventual perception hit as that business went away. Second, and perhaps more egregious than the misleading margin concerns, was Mr. Croteau's promise to "backfill" the divested Automotive revenue through organic growth in lasers and optical components "within a few quarters." In the body of our report on this section, we clearly show that the Company's proud statement that it had filled the revenue hole just six months later was misleading as the vast majority of the revenue came from two acquisitions completed in December 2015.
· More recently, on its F2Q16 earnings call, MTSI CEO "guaranteed" that organic revenue growth QoQ was "double-digits" in F1Q16. MTSI's SEC disclosures reveal F1Q16 organic revenue was down 1.2% q/q and F2Q16 was up only 3.2% q/q. These numbers are obviously grossly decoupled from Mr. Croteau's guarantee. While the complacent sell-side refuses to fact check MTSI's misleading statements, we provide all of the analysis necessary to determine the actual growth rates.
· Since acquiring BinOptics, MTSI has repeatedly alluded to doubling its capacity in the first six months after closing the deal and quadrupling it within a year. Inline with these claims, MTSI's analyst day presentation depicted laser shipments almost quadrupling from F1Q15 (the quarter BinOptics was acquired) to F1Q16. Yet the story does not appear to reconcile with basic math, which suggests a disturbing number of discrepancies exist between management's verbal statements and what is disclosed in SEC filings. For example, MTSI's 10-Q and 10-K filings break out BinOptics full quarter revenue and indicate that BinOptics revenue were up only 44% in F3Q15 compared to the full pre-acquisition F1Q15 quarter, despite statements that the business doubled in six months. MTSI's comments about capacity increases and analyst day slides showing a 4x increase in shipments look highly misleading if the price breaks offered to customers resulted in much slower revenue growth.
III. Three Growth Opportunities: Still "Pie-in-the-Sky" After Years of Hype
· 1) GaN is one of the three product areas that MTSI claims can double the company's revenue in 3 - 5 years. MTSI told investors GaN was a major growth driver two years ago. Management stated that they would disrupt the basestation power amplifier market (current LDMOS technology) and capture 80% market share of the $2.5 billion addressable market. A careful analysis of the market suggests MTSI's GaN is nothing more than a glorified R&D project with highly uncertain prospects that will not see rubber meet the road for many years. Obviously, MTSI has not disrupted the market, and contrary to the CFO's unambiguous statement that all "exciting opportunities" were "designed and qualified" as of May 2014, MTSI's GaN product for basestations is yet to be qualified. The crux of the GaN argument is that it performs better at higher frequencies and there is speculation that the 5G wireless standard may spur the use of higher frequency bands. While the opportunity with 5G is unknown, deployments are at least 5 years out based on the Next Generation Mobile Networks Alliance estimates. Further, there is no obvious reason for mobile network operators to undertake the hassle and cost of re-qualifying mature and cost-optimized 4G basestation equipment if the frequency bands do not change and GaN equipment costs are similar. Second, these higher frequencies have severe limitations due to signal loss and an inability to penetrate walls. As a result, the technical feasibility of higher frequencies is debatable, while the economic appeal has yet to be proven. Third, high frequencies are not licensed for cellular use in the US or anywhere else. The FCC started exploring this idea in October 2015 and has ran into an opposition from the satellite industry. In this context, MTSI's plan to qualify the GaN products in summer 2016 and ramp revenue in by the end of the year seems consistent with so many of the Company's promises since coming public. As such, we would expect to hear more of management's selective disclosures from recent investor conferences that GaN revenue may slip out of 2016 and into 2017.
· 2) Active Antennas are the second growth driver that MTSI claims should double its revenue in 3 - 5 years. The crux of this story centers on the ramp of military and civil radars that use electronic scanning (a large number of small modules on radar surface scanning different segments of space simultaneously as opposed to traditional passive scanning). MTSI has built "tiles" that are building blocks for such radars. It has been two years since MTSI announced a $300 million program "under way" to upgrade F-16 fighter planes and other opportunities in active antennas, the biggest one being MPAR - the aspirational program to upgrade 350 radars in the US for an opportunity of $500 million per year. Despite intermediate promises to see MPAR or Active Antenna revenue as far back as F3Q15 or F4Q15, the contribution to MTSI revenue remains negligible, as evidenced in MTSI's 2016 analyst day slides and commentary. While government program delays are common, the MPAR deployment timelines of two agencies driving the MPAR program - NOAA and FAA, illustrate how deceptive and unrealistic MTSI's promises appear. In a 2015 report to the Congress, NOAA set out a timeline for MPAR deployment starting in 2025, which is a timeline similar to what the FAA has presented. How can MTSI argue that active antennas will be a key driver of revenue doubling over the next 3 - 5 years when its customers do not expect deployments for nine years?
· 3) Optical components, especially 100G, are MTSI's third growth area behind its promise to double revenue in 3 - 5 years. Unsurprisingly, this segment looks nearly identical to the first two segments: (NYSE:I) promoted for a couple years without tangible results, (ii) aiming at a future market that is yet to materialize, with products that are not yet qualified (25G lasers), and at cost points that are not yet market-proven. To be clear, MTSI has analog components that can be used in 100G datacenter equipment, but the "big opportunity" is selling 25G lasers to major datacenter operators for 100G transition. With the inherited portfolio of 2.5G PON lasers from BinOptics, the transition to 25G lasers may appear reasonable. However, MTSI does not have a working 25G laser at the required yield levels, and our diligence with optical component vendors unequivocally suggests that MTSI it is not close to having a working 25G laser. Nonetheless, we believe MTSI continues to mislead/misrepresent its 25G laser product progress, as evidenced by the highly misleading January 2016 press release stating AAOI has placed orders, and its F2Q16 earnings call statement that 25G lasers are already shipping (only to reveal later that these are not at required yield points and a real "inflection point" is more like 2017).
IV. China and BinOptics - Double- or Triple-Ordering
· BinOptics has been running heavily capacity constrained for several quarters, selling to Chinese OEMs who are notorious for double-ordering (e.g. Huawei). MTSI's own recent forecast for the PON market had the industry growth (i.e. demand) stalling in 2016, which was ironically coincident with BinOptics adding capacity (i.e. no more incentive to double-order). While MTSI has pointed to a 4K transition and more content per box to combat investor fears of a China PON meltdown, data points continue to emerge (such as from Taiwanese module maker eLASER or US-based SemTech), of a demand slowdown and inventory digestion. With BinOptics as the only meaningful organic growth segment within MTSI (we estimate approximately 20% of revenue), the impact of a PON slowdown should be significant and is not reflected in consensus estimates.
· A second major risk to MTSI on its optical segment is the possibility of the US Commerce Department imposing sanctions against MTSI's largest customer Huawei. The U.S. Commerce Department recently subpoenaed Huawei on June 2, 2016 based on its involvement in Iran and Syria. ZTE was sanctioned earlier in March and is operating under temporary relief through August 30, 2016. With Huawei accounting for 17% MTSI F2Q16 revenue, and driving virtually all of the organic revenue growth in F1H16, sanctions are a material risk for MTSI.
V. Consensus Estimates Imply A Baseless Growth Inflection. Fair Value < $21.08
· Since its IPO four years ago, MTSI has delivered average organic revenue 8% below the prevailing consensus estimates when each fiscal year began. Acquisitions and accounting shenanigans have masked an ugly 6% negative organic revenue CAGR from FY2012 to FY2015, which contrasts with management's high growth claims.
· Through the BinOptics acquisition, MTSI has captured share in China's PON build out through pricing that Avago and Mitsubishi wouldn't match. It is unsurprising that Huawei has become the largest customer of MTSI. However, this growth at Huawei has masked a revenue decline of 1% y/y in F1H16 from all of MTSI's other customers. The incipient data points supporting a PON slowdown, combined with potential sanctions on Huawei, creates material risk that the modest organic growth experienced in FY2016 will not continue.
· As a result, we believe consensus estimates for F2H16, and more importantly for FY2017 where estimates imply 14% organic revenue growth, are meaningfully mis-modeled. The overwhelming body of evidence suggests MTSI's three proclaimed growth opportunities (GaN, Active Antennas and Datacenter 100g) are unlikely to materialize any time soon, if ever. Barring additional acquisitions that obfuscate growth trends, we believe MTSI's FY2017 revenue growth will reflect its multi-year organic revenue trajectory of flattish growth at best.
· Generously assuming MTSI can overcome its margin dilutive acquisitions and return to 60% gross margin in FY2017, we estimate Non-GAAP EPS will fail to grow materially in FY2017. In light of the long-tail risks to its business, organic growth declines, material insider selling on a story we believe was misrepresented, and estimates that are too high, we see no reason investors will pay up for MTSI. Applying the 12x P/E multiple (generous for a debt-burdened, no-growth company that has a mark-to-reality ahead), we estimate fair value to be no more than $21.08 per share, or 39% below recent market prices.
Please read this Disclaimer in its entirety before continuing to read any opinions from Cold Shower Analytics. You should do your own research and due diligence before making any investment decision with respect to securities covered herein. As of the date this opinion is posted, the author of this report has a short position in M/A-COM and stands to realize gains in the event the price of the stock declines. Following publication of this report, the author may transact in the securities of the company, and may be long, short, or neutral at any time hereafter regardless of our initial opinion. To the best of our ability and belief, all information contained herein is accurate and reliable, and has been obtained from public sources we believe to be accurate and reliable. However, such information is presented "as is," without warranty of any kind - whether express or implied. The author of this report makes no representations, express or implied, as to the timeliness or completeness of any such information or with regard to the results to be obtained from its use. All expressions of opinion are subject to change without notice and the author does not undertake to update or supplement this report or any of the information contained herein. This is not an offer to buy any security, nor shall any security be offered or sold to any person, in any jurisdiction in which such offer would be unlawful under the securities laws of such jurisdiction.
Disclosure: I am/we are short MTSI.