Description
ChipMOS Technologies (IMOS) trades for 3.0x 2006E EBITDA, 2.5x 2007E EBITDA, 6.3x 2006E EPS and 6.0x 2007E EPS. I don’t know about you, but I generally haven’t lost money buying businesses at those prices. So that’s a pretty good starting point. If the company traded for 4x EBITDA, the stock would be $13, up over 100% from here. Does 4x seem like an unreasonable assumption? Consider that the Carlyle Group is reportedly in discussions to acquire ASX Group (one of ChipMOS’ peers) for 5.2x EBITDA which would translate into a price of at least $19 for IMOS.
Company Overview
IMOS provides testing and assembly services for semiconductor manufacturers. Jay912 did an excellent write-up on the company a year ago at roughly the same price. The company has done nothing but outperform expectations since then but the stock has gone no where. IMOS is the 5th largest provider of its services and is based in Taiwan. The corporate structure is rather complex (HQ in Bermuda) but the stock is fairly liquid on the NASDAQ.
ChipMOS focuses on two primary markets: memory (both DRAM and flash) and LCD drivers. These niche markets haven’t drawn the same level of competition from peers as the logic, wireless analog semiconductor markets have.
The three key drivers of IMOS’ business are:
· DDR2 transition (DRAM memory technology)
· Flash memory ramp
· LCD TV sets
IMOS’ recent revenue mix has consisted of approximately 55% from DRAM, 15% from NOR flash and 20% from LCD.
One of the things that hurt IMOS last year was an early entry/investment in DDR2 memory assembly and testing and it carried excess capacity for a while. IMOS built it and now “they” are coming. “They” being customers as the DRAM business moves to DDR2.
DDR2 is attractive for IMOS because DDR2 results in higher ASPs by a factor of almost 2x. This obviously makes IMOS’ relatively small contribution to the process less sensitive to squeezes from price swings.
IMOS continues to win business and entered into a long-term supply agreement with a major U.S. NOR flash memory provider. This should allow IMOS to grow faster than the industry, especially if this customer makes a push into the NAND flash market.
The company’s top five customers for 2005 were ProMOS, Powerchip, Himax, Novatek and Elite. These customers accounted for 63% of total 2005 revenue.
ROIC
The testing business has been perceived as a low-ROIC business but historical trends for IMOS show that hasn’t been the case (even with IMOS’ heavy capex spending). My definition of ROIC is after-tax operating income divided by average invested capital (i.e., standard NOPAT-type calculation).
|
Year |
ROIC |
Adjusted ROIC* |
|
2002 |
Negative |
Negative |
|
2003 |
4.2% |
8.4% |
|
2004 |
12.8% |
17.3% |
|
2005 |
9.3% |
13.8% |
|
2006 YTD |
13.4% |
18.2% |
* Adjusted ROIC assumes equipment is depreciated over seven years as is industry standard. IMOS depreciates most equipment over five years. This also better ties IMOS’ depreciation to maintenance capex.
Capex
Capex for 2007 is expected to be as low as $250M (down from $460M in 2006) allowing IMOS to report positive free cash flow for the first time since the investment cycle started. FCF does not lie and perhaps this will be a catalyst for the stock.
IMOS has invested heavily to prepare for the transition to DDR2 and is well ahead of its peers in that regard. Consequently, most of the heavy capex is in the rearview mirror.
I believe maintenance capex is $100M or less. Accordingly, depreciation (~$175M) exceeds maintenance capex by a factor of about 1.6x.
Cyclicality
While there is some cyclicality in the testing business, IMOS has generally produced consistent and growing earnings. 2005 was considered a bad year for IMOS and the company still earned $.56. That “bad” year has helped set the stage for 2006 and beyond as the reason the company had a bad year is because they were investing heavily in DDR2 testing capacity without corresponding revenue from such capacity.
The cyclicality perception comes from the wild swings in DRAM prices which primarily affect DRAM manufacturing. Of course a dramatic decrease in DRAM prices could put pricing pressure on IMOS and the industry but the key for IMOS is volume. Even with DRAM price swings, the semis still seem to always get manufactured.
Further reducing the cyclicality from IMOS is certain long-term contracts. These contracts have take-or-pay type mechanisms and account for approximately 34% of IMOS’ revenue.
Recent Revenue Trends
The company reports monthly revenue and growth has recently been accelerating.
|
|
|
2005 |
M/M % |
Y/Y % |
|
2006 |
M/M % |
Y/Y % |
|
|
|
|
|
|
|
|
|
|
|
January |
|
1,115.0 |
-11.6% |
17.9% |
|
1,418.8 |
-4.8% |
27.2% |
|
February |
|
1,029.2 |
-7.7% |
2.5% |
|
1,407.0 |
-0.8% |
36.7% |
|
March |
|
1,195.3 |
16.1% |
4.9% |
|
1,541.3 |
9.5% |
28.9% |
|
1Q Subtotal |
3,339.5 |
|
|
|
4,367.1 |
|
30.8% |
|
April |
|
1,193.2 |
-0.2% |
-12.9% |
|
1,584.6 |
2.8% |
32.8% |
|
May |
|
1,283.6 |
7.6% |
-15.2% |
|
1,553.6 |
-2.0% |
21.0% |
|
June |
|
1,278.4 |
-0.4% |
-11.2% |
|
1,636.5 |
5.3% |
28.0% |
|
2Q Subtotal |
3,755.2 |
|
|
|
4,774.7 |
|
27.1% |
|
July |
|
1,215.1 |
-5.0% |
-5.7% |
|
1,681.7 |
2.8% |
38.4% |
|
August |
|
1,277.8 |
5.2% |
-4.2% |
|
1,768.2 |
5.1% |
38.4% |
|
September |
|
1,343.5 |
5.1% |
1.6% |
|
1,862.6 |
5.3% |
38.6% |
|
3Q Subtotal |
3,836.4 |
|
|
|
5,312.5 |
|
38.5% |
|
October |
|
1,373.9 |
2.3% |
11.4% |
|
1,955.1 |
5.0% |
42.3% |
|
November |
|
1,424.2 |
3.7% |
20.2% |
|
|
|
|
|
December |
|
1,490.7 |
4.7% |
18.2% |
|
|
|
|
|
4Q Subtotal |
4,288.8 |
|
|
|
|
|
|
Valuation
The stock swooned earlier in the year as Mosel Vitelic (which is affiliated with ProMOS, a memory manufacturer and major customer for IMOS) sold 7mm shares of IMOS in a May offering. Mosel still owns 19mm shares of IMOS. In addition, Amaranth was a large holder of IMOS which further pressured the stock.
I don’t know what the right valuation method or metric for this company, I just know it’s substantially higher than here. This one doesn’t require a calculator to assess the risk/reward. The Carlyle Group’s bid of 5.2x EBITDA certainly doesn’t seem outrageous. Again, at 5.2x EBITDA, IMOS would trade at over $19/share.
Here is some information on comparable valuations:
|
Company |
P/E – 2006E |
P/E – 2007E |
EV/EBITDA 2006E |
EV/EBITDA 2007E |
|
ASX |
9.0x |
9.8x |
5.7x |
5.2x |
|
AMKR |
11.2x |
12.4x |
6.0x |
6.1x |
|
SPIL |
10.6x |
10.6x |
6.4x |
6.3x |
|
STTS |
21.4x |
14.3x |
5.3x |
4.8x |
|
ASTSF |
9.1x |
10.2x |
4.2x |
4.4x |
|
Mean |
12.3x |
11.5x |
5.5x |
5.3x |
|
IMOS |
6.3x |
6.0x |
3.0x |
2.5x |
Also, IMOS trades for 1.4x book value while its peers trade for 3.2x.
IMOS is clearly “out of cycle” as it relates to the favor of the market. Given that IMOS trades close to trough valuation metrics, this makes for a timely contrarian play.
Catalyst
Carlyle Group buyout of competitor at significantly higher valuation
Reversion to the mean--trade up off historical trough valuation
Continued above industry growth
Solid FCF for 2007; significantly reduced capex
Time