|Shares Out. (in M):||28||P/E||0||0|
|Market Cap (in $M):||153||P/FCF||0||0|
|Net Debt (in $M):||-64||EBIT||0||0|
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I believe Emcore (EMKR) represents a compelling long opportunity at current levels.
What do they do?
At its core, EMKR focuses on mixed signal optics chips and deploys this core technology in various applications. The vast majority of its business is products that go into the cable TV (CATV) end market, but they also serve satcom, wireless, navigation/defense, and telecom networking. EMKR uses its indium phosphide wafer fabrication facility in CA as the basis for producing all of its products. In general EMKR focuses on production of the core chips using their own fab, while outsourcing a lot the construction of full components and subsystems to either their facilities in China or to external partners. They break out their business in 3 product lines:
For CATV (79% of FY17 revenue and the bulk of their ‘broadband’ segment), and without getting into too much detail, EMKR’s wide range of fiber optic transmitters, receivers, amplifiers, switches, lasers, etc “comprise a complete end-to-end CATV system” (as they state it).
For everything else (21% of FY17 revenue), satcom and chip devices have been the largest, but navigation (more below) represents the biggest potential revenue opportunity.
I go into more detail on the CATV and Navigation pieces of their business below.
New Management & Improved Fundamentals
EMKR essentially went through a wholesale leadership change starting 4 years ago, which was catalyzed by an activist investor (Stephen Becker).
And financial performance has improved dramatically since…
Note that EPS here (and below) is non-GAAP (adds back SBC) and is untaxed. The company has $425M in NOLs (discussed more below) so they will not be a cash taxpayer for the foreseeable future.
The improved financial performance has been both due to internal actions taken and growth in the CATV market:
Altogether, under new management revenues more than doubled while they went from large losses to healthy profitability. While there have been some issues the last couple quarters that have hit the stock (addressed below), the company has executed quite well under current management over a multi-year period.
Recent results – some disappointments
Despite the strong multi-year performance, recently the company has had some hiccups, resulting in the stock being down over 50% from its 52 week high. Each of the last two quarterly reports have been accompanied by weak forward guidance:
So together, these two issues explain roughly a $7M-$8M decline in quarterly revenues that they’re currently seeing (revenue trough should be in Q2), taking them down from ~$30M/quarter in revenue to the low $20Ms. And, as a result, the stock has been marked down about 50% off its 52 week highs (with the EV down by more like 2/3).
FY18 Guidance - Street Consensus Seems Too Low
It’s interesting that while management does not give formal revenue guidance out beyond one quarter, in the most recent call, they gave enough data to triangulate in on a full year FY18 revenue number. My discussions with the company about this indicate that this was not accidental/unintentional and they agree with the math below. The implied revenue number based on the guidance data points they’ve given is MUCH higher than where the newly lowered street numbers are. The street has clearly set a low bar after a couple misses. Here are the data points they gave and how it translates into an implied full year estimate (all from the recent Q118 earnings call):
Here is how I’ve penciled out the quarters to match the implied annual revenue guidance (Q1 is actual, Q2 has been specifically guided to on the top line):
Street consensus numbers (4 analysts) are:
As can be seen, taking guidance at face value suggests the company can roughly double consensus EPS in 2H18 and exit the year at a $0.80 annual EPS run-rate. Clearly very attractive on a $5.50 stock with $2.30/shr in cash. Using a 15x multiple on that Q4 run-rate and adding in the cash, yields a $14+ stock.
The obvious question here is whether this revenue ramp from ~$22M in Q2 to mid-$30Ms in Q4 is reasonable. My take is that a normalization of CATV revenue puts them back in the neighborhood of $30M (they’ve done low $30Ms in quarterly revenue going back to early CY17). At the Needham conference in January, the CEO talked about growth in Chip Devices of around 100% Y/Y in FY18 (off a few $M/qtr base) and growth of several hundred percent in Navigation (Q1 was ~$1M), so the pieces seem to be there for guidance to be achievable (i.e. achieving that mid-$30Ms revenue level by Q4), though they obviously have to execute well. Given the delta between guidance and where the street is at, they should at least have some margin for error in exceeding consensus. Obviously there is a fair amount of speculation here on my part. The main point here is that this is what the company is guiding to and it’s way ahead of the street. From the outside, it’s impossible to know for sure everything they see in how they’ll get there, but I like the seemingly low bar that’s in place for them.
Given that CATV is still expected to be in the neighborhood of 2/3 of revenue in FY18, it will remain the biggest driver of the business overall in the near term, for better or worse. The biggest driver right now for CATV infrastructure spend is DOCSIS 3.1, where I believe we are still in the early innings. To assess some industry numbers, we can look at both EMKR’s CATV customers (equipment OEMs) and cable MSOs.
EMKR has consistently had two large OEM customers for their CATV products, ARRS and CSCO, with ARRS being somewhat larger. Together the two have historically represented 75% or more of EMKR’s CATV revenues. Given ARRS is more of a pure play into cable MSOs (CSCO is far too diversified to yield any read-through on EMKR’s CATV business), ARRS’s outlook is probably the most instructive to look to for trends in EMKR’s CATV business. Current estimates call for ARRS to grow revenues by 9% Y/Y in CY18, indicating a healthy backdrop in CATV.
We can also look at CapEx expectations for the major cable operators. The biggest drivers of industry spend (as I understand it) are shown here (Comcast/Charter in N.A., Liberty Global in Europe):
The cable CapEx numbers create a somewhat mixed picture with Charter/Liberty, in aggregate, relatively flat, and Comcast appearing to decline. When I’ve dug into Comcast a bit, what I’ve learned is that the bigger piece of the CapEx decline is in CPE (customer premise equipment, or set-top boxes) rather than infrastructure (what impacts EMKR). Taken together, I’d characterize the environment in cable as likely flat to very slightly down in CY18.
Taking into account both the expectations for ARRS and the cable operators paints a mixed, perhaps very modestly negative picture, but nowhere near as negative as EMKR’s communicated expectation for a ~25% decline in their CATV business in FY18 (due largely to the couple issues already discussed), suggesting EMKR should be much more likely to see a meaningful upward reversion in their CATV business from currently depressed levels rather than a further erosion.
The Navigation/Defense opportunity is relatively nascent for EMKR yet it represents a very large opportunity relative to the current size of EMKR’s business. It currently is less than 5% of revenue (I believe it is essentially all one program currently), but is expected to grow by a “couple hundred percent” in FY18 vs FY17. EMKR is leveraging its core mixed signal optics technology to sell FOG (fiber optic gyroscope) technology to be used for navigation in various defense applications. Basically, the background here is that in sensitive defense applications, traditional GPS technology is insufficient because it can too easily be denied/”jammed”, thus the need for fiber optic gyro technology. Currently, EMKR is the only merchant supplier selling FOGs. While all defense OEMs produce products (autonomous vehicles, missiles, etc) that utilize the technology, currently NOC and HON are the predominant producers of FOGs. Thus, other defense suppliers are often in the odd position of having to acquire this technology currently from one of their competitors. The opportunity for EMKR is thus to supply to RTN, LMT, BAE Systems, etc. This is approximately a $1.5B TAM, with about half available to EMKR (i.e. non-NOC, HON programs). It will take some time to keep winning programs to move toward the multi-year goal of this being on the order of a ~$100M business (similar size to CATV is a stated multi-year target), but the progress disclosed so far is:
At this point, this business is too small to move the needle much in the near term, but over a couple years can represent a meaningful revenue growth driver at above corporate average GMs. Achieving their multi-year goals here in terms of revenue scale could represent a “home run” scenario for the stock and at the current valuation, I’d argue you’re basically getting a free call option on this business.
Shareholder-friendly capital allocation
As highlighted above, if the company executes as guided, this can potentially be a mid-teens stock by year end (and potentially much higher on a multi-year basis if Navigation takes off). In addition to this very attractive upside, I think there’s fairly solid downside protection here for a number of reasons:
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