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InvenSense 3Q comprehensive analysis +3

07:04 30-Jan-15


I apologize in advance for the length of this.  Hopefully you find it worthwhile for both today and months to come.  Here's a table of contents with summaries to help you find and navigate the content quickly:

Financial Figures Recap
Short Term: (AH due to misreporting, margins not a concern, further rebound very likely)
Medium Term: (what we learned about the Apple deal, next catalysts)
Long Term: (balance sheet assessment, valuation, future tech)
 
3Q15 Financial Recap:
 Short Term: (AH due to misreporting, margins not a concern, further rebound very likely)

I am of the firm belief that most of the after hours reaction was caused by misreporting.  On most brokerages (TDAmeritrade & ETrade, at least) Dow Jones was reporting, "InvenSense 3Q Adj EPS 5c" (last quarter's #?), which would have been a huge miss.  With traders still remembering the debacle of GTAT, another Apple supplier, it's easy to believe they saw that and hit the panic button.  This was still uncorrected as of 2AM Friday morning.

SeekingAlpha also misreported the revenue figure as a big miss of $90.2M (again, last quarter), and took over a half hour to make a correction despite myself and many others notifying them of the error immediately.  Correcting the YoY revenue % gain took even longer and the correction is undocumented.  This news post tries to claim the AH movement is to margin concerns, with no mention of their errors.

That's not very plausible at all.  Gross margins improved, pretty much exactly as predicted by management and in my Pro article, and the forecast is for them to stay steady or improve a little more from here.  Operating margin improvement was even better, and nobody was realisticcally expecting more than what we saw in this report.  Furthermore, if margin concerns really were the problem, then the stock would not have rebounded as it did.  As analysts and investors digest the figures, gross margin simply won't be an issue, particularly in light of the operating margin improvement.  It's natural for margins to compress as a business matures and any rational company, analyst or investor should be happy to see higher profit, revenue, diversity and volume at the cost of lower margins.

By close of AH, INVN had recovered from a low in the mid 13s to above $15.  Given 27% of float shorted as of mid-January and daily figures suggesting it may have even risen from there, it seems likely that the rebound will continue in days to come.  I much prefer the rebate rate as a real-time indicator, since it can't be fudged in ways discussed here.  It's also possible that the short side trying steer market reaction by manipulating AH pricing was also a factor.  If you don't think this happens, all I can say is, you've never worked for a HFT hedge fund.  (I have.)  The rebate rate had been fairly steady, but very high, around 25% since this comment.  What all this means, is that there is still a huge short contingent out there that is looking at losing 25% of their capital over the next year if INVN merely stays where it is.

This was a fundamentally good report, that shows InvenSense has a very good business none of the feared inventory or other problems.  For that reason alone, shorts are going to cover, and from their perspective, the sooner the better.  The possibility of buyout several suitors looms in addition to many other factors detailed below.

Medium Term: (what we learned about the Apple deal and next catalysts)

The conference call told us some important things.  Perhaps the most interesting is that 69% of revenue came from 2 10-percent customers.  Although they were not named, we can be all but certain that the 45% customer is Apple, and the 24% customer is Samsung.  From that I calculate that InvenSense did $52.155M in sales to Apple.  CIRP estimates that 75% of iPhones sold were the new model 6 versions. For all you Apple watchers, 40% of those were Plus, despite limited availability, partially confirming my theory that part of Apple's success in this product cycle is due to previously unfulfilled demand for a larger screen.  So 75% of 74.5 iPhones sold gives us 55.875M parts that InvenSense supplied to Apple.  That would be over 93 cents per part, which is higher than the 90 cent maximum that I proposed earlier.  There are a few possible explanations for the discrepancy:
  1. My earlier estimate is wrong.
  2. InvenSense received money for something other than parts from Apple.
  3. CIRP's estimate is wrong.

The first two are certainly possible, and none of these options are exclusive.  Management did say they earned money from software this quarter, but I believe they were referring to Xiaomi.  So, I think #3 is most likely.  CIRP uses a survey of 500 U.S. respondents, so statistically speaking, we should expect a deviation range of ~4% on a population of 74.5M.  If we figure that 79% of iPhone sales were the newest models, then the price per InvenSense part comes to 88.6 cents each.  I think we can reasonably conclude that pricing is towards the high end of my range, and that most of the ways in which this logic could be wrong would wind up implying an even better situation for InvenSense.

Since Tim Cook has stated that iPhone supply only caught up to demand in January, and InvenSense management stated that Day Sales Outstanding was 58, we can also infer that InvenSense has another good quarter coming.  When I also consider management's implied confirmation of a design Xiaomi's new flagship, I begin to think that characterization of guidance as "conservative" may have been an understatement.  Finally management also specified that there are 92.3M shares outstanding, indicating that increase from acquisitions almost complete, which should eliminate a drag on the financial figures going forward.

The one caveat to all of this is perhaps the only problem you almost want a company in InvenSense's position to have: it's priced like a superstar, currently sporting a 1yr forward PE of 20.  FWIW, that doesn't compare badly to some other fabless chip makers; NVDA has a forward PE of 18.  Still, comparing one pricey stock to another doesn't make either of them cheap.  However, rising revenue and profits makes for somewhat more reasonable valuation by other metrics.  Using 2 actual and 2 estimated sales figures from 2Q15 thru 1Q16 gives earnings of $395M and P/S ratio of 3.5.  If InvenSense can even come close to delivering on its stated hopes to double content share in 2016, it will start to look like more of a value.  In the meantime, I note that perhaps the cardinal rule of shorting is not to do it on value alone.  Those tempted to ignore this rule might note following positive catalysts approaching:
 Long Term: (balance sheet assessment, valuation, future tech)

In the meantime, InvenSense management is on the path to technological and financial health.  On the finance side, the balance sheet is already starting to rebuild.  Even before this report, the Quick & Current ratios of 4.3 and 4.5 were already looking very healthy again.  Cash & Investments, which due to multiple acquisitions and costs related to the extensive qualification process with Apple, had eroded down to a $96M low 1 yr ago, is already back up to $172M.  That alone adds $1.86 to the stock price, and the figure should continue to grow.

Let's say InvenSense does come close to its goal of doubling its sales in CY 2016 and simply maintains its current 17% operating margin.  Then we might have revenue of around $790M for the year, resulting in the following EPS calculation

Revenue
  x Operating Margin
  = Net Income
  / Shares
  = EPS
$790M
 17%
 $134.3
 92.3M
 $1.45

If we assume that sensors are continuing to proliferate, enabling a continued growth outlook, that might merit a PE of 20 for a 2016 stock value of $29.  If we discount by 10% per year twice (let's say it takes until the end of 2016 to achieve this), then we could project a current fair value of $23.49.  Add in cash from the balance sheet and you're well above the $24 long-term price target that I set before the last earnings catastrophe.  Is INVN going to get there tomorrow or even this quarter?  Probably not sustainably, though who knows what prices a short squeeze would bring.  Still, you can see where such price targets are coming from and how an buyer might look at the company, especially given the InvenSense customer list.

On the technology development side, the company has lots of hard-to-find irons in the fire too:
 In the meantime, you can expect me to publish the content from at least the Medium and Long term sections of this brain dump in the days to come, probably as a Pro article, but who knows, given recent experience.

Thanks for reading, and goodnight!
Esekla

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All content is the author's opinion, rather than investment advice.