|Shares Out. (in M):||89||P/E||0.0x||21.0x|
|Market Cap (in $M):||285||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||-130||EBIT||0||0|
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Entropic Communications (ENTR) is a forgotten company, its stock down 75% from its peak as the company saw meaningful market share loss to semiconductor giant Broadcom (BRCM). There is now a clear path to much better operating results over a multi-quarter period and there is much to like in this invesment: ten different insiders, including the CEO and CFO, have purchased stock, nearly fifty percent of the market cap is in cash and the company has now found its potential savior in the unlikeliest of places: a bankrupt semiconductor company.
ENTR designs chips for a $1.6 billion market that is growing at a 10-14% annual rate in which they have about 7% market share. We believe over the next two years ENTR can increase that market share to 20%, doubling revenues, and producing EPS of $0.60. We believe ENTR is on a path towards becoming the set-top box (STB) industry’s number two silicon provider making it a likely target for a large semiconductor manufacturer that will want to own ENTR for its technological prowess as well as its earnings accretion potential. Simply, if ENTR is successful we believe the company’s ~$3.25 stock could be worth $10.00 (15x 2016 EPS of $0.60 plus $1.00 per share in cash), up over 200%.
ENTR is a fabless semiconductor company that designs and sells media processing chips to cable and satellite STB manufacturers. These chips enable multi-room DVR capability (MoCA- multimedia over coax), multi-TV satellite dish transmission (CSS – channel stacking switch), and applications processing (SoC - system on a chip). ENTR's heyday was spurred by their pioneering of the MoCA standard which ENTR invented in order to enable cable and satellite subscribers to pause a show on their DVR in one room and restart it in another. ENTR had great success early on with two early adopters: Verizon (VZ) and DirecTV (DTV), but ran into a big problem with semiconductor heavyweight BRCM in 2011. MoCA was designed to be an industrywide standard and thus had to be shared across the ecosystem, even with ENTR’s competitors. As a result, BRCM and its $2 billion R&D budget integrated MoCA technology directly into their STB SoCs, obviating the need for a separate MoCA chip provided by ENTR. ENTR rapidly lost market share, its stock declined from $13 to $3 and today sells few discrete MoCA chips to STB manufacturers. ENTR's outlook was bleak: how could they compete with a company like BRCM that could simply integrate MoCA functionality directly into the silicon of the much more important SoC when ENTR simply did not make SoCs? And then something serendipitous happened: BRCM helped put SoC vendor Trident Microsystems out of business.
Trident was once a mighty company, peaking at annual sales of $560 million in 2010. But underneath this seemingly healthy veneer, Trident was built piecemeal, held together via numerous ill-advised acquisitions. Ultimately, the company failed because it chose to focus on producing SoCs for the very large, yet rapidly deflationary television market while neglecting its more defensible STB SoC product line. ENTR ended up buying Trident's STB SoC business for $65 million shortly after Trident's bankruptcy in April 2012. The acquisition gave ENTR the technological prowess necessary to go toe-to-toe with BRCM and regain market share in the STB market. The technology world moves quite rapidly but in this case it would take two years of engineering development at the new ENTR to create a truly competitive solution. But even before ENTR's deep pockets and focus enabled them to fully catch up in functionality to BRCM they won some major STB design wins at Tier 1 providers.
ENTR has publicly announced a major design win with Comcast (CMCSA), the country's largest cable provider. ENTR will be providing a bundled SoC and MoCA solution to enable Comcast's new X1 and X2 platforms which are set to roll out late 2014. It’s hard to understate the importance of being selected by CMCSA as a chipset vendor. CMCSA provides industry-leading R&D in the cable space and largely sets the technological roadmap for the rest of the country's cable providers. CMCSA’s competitors, including Time Warner Cable (TWC), Charter (CHTR), and Cox, all standardize on Comcast’s reference designs, specifications, and architecture. In short, the silicon provider CMCSA picks is typically what the rest of the industry ultimately chooses.
We believe there are two very good reasons that ENTR received this important design win despite still offering a solution that is more expensive than BRCM's. First, the cable and satellite operators are leery of BRCM's market dominance, with the company controlling nearly 90% market share in STB SoCs. Having such large market share stifles innovation, increases supply risk, and concentrates power in the hands of one supplier. Second, CMCSA's move to the X1 and X2 platforms represents a seismic shift for them technologically. No longer will they deliver video to customers via old QAM (digital cable) technology; the cable world is moving to IP (internet protocol) which enables CMCSA and other providers to offer customers highly specialized content and advertising. This major technological shift has enabled ENTR to get its foot in the door and the company has successfully used it to wedge its way further into BRCM's domain. ENTR has since announced two more major design wins that will begin rolling out during the second half of 2014: one with a satellite provider (we believe it is DIRECTV - DTV) and one with another cable provider (likely TWC). Again, ENTR has won three major designs despite offering an un-integrated chip twenty percent more expensive than the comparable one from BRCM. Even more exciting is the fact that ENTR will soon be on even footing with BRCM on pricing; it is currently sampling an integrated chip that matches the one BRCM used to steal large amounts of market share from ENTR beginning three years ago. The integrated MoCA-SoC chip should start generating revenue for ENTR in the first half of 2015.
Despite the news surrounding ENTR's announced design wins, the company has yet to generate meaningful incremental revenue. In fact, ENTR's last announced quarter, Q114, saw revenue decline 25% Y/Y. We believe ENTR's recent design wins portend a large recovery for the company and its shares over the next several quarters.
We spoke with STB OEMs, competitors, and former employees and we liked what we heard: the industry is desperate for a number two challenger to BRCM. ENTR was awarded this first set of design wins because their technology meets the same specs as BRCM. In fact, ENTR may have an advantage over BRCM longer term, as they base their SoCs on the widely used ARM standard, while Broadcom favors older MIPS technology. These discussions with industry experts give us the confidence that ENTR has a real opportunity to grow revenue and earnings meaningfully over the next 18 months.
DISCLAIMER: The author is long ENTR. This is not a recommendation to buy or sell any investment. Additionally, this document should not be relied upon to make an investment decision as the numbers and figures presented are solely the author’s estimates. Investors should contact the company directly and read ENTR public filings to form their own opinions and make their own investment decisions. The author may transact in the securities of ENTR without notice.