|Shares Out. (in M):||26||P/E||0||0|
|Market Cap (in $M):||58||P/FCF||0||0|
|Net Debt (in $M):||-58||EBIT||0||0|
O2Micro (NASDAQ: OIIM) is a Taiwanese electronics firm focused on LED and power management products, which currently trades at a discount to unrestricted cash and a deep discount to tangible book value, and has recently begun monetizing non-core real estate and investment assets while buying back stock at attractive levels. The recent involvement of an activist value investor should act as a significant catalyst for shareholder value to be realized.
Sales and business outlook
OIIMs sales and profitability have been volatile and sensitive to demand for its semiconductor products, and the company has experienced manufacturing problems contributing to recent GAAP losses and revenue declines. Weak notebook sales and a manufacturing problem affecting a key charger product have pressured sales and earnings during 2014-15, and OIIMs NASDAQ-traded American Depository Shares (ADSs) have sold off to $2.35, representing a sharp decline from recent highs of over $3.90 in May 2014 and previous 2007 highs of more than $17. Despite recent revenue weakness over the last two years, the company recently earned positive EBIT of $23.4 million in FY2010 and $10.1 million in FY2011. At an outstanding share count of approximately 26 million ADS equivalents and a current market cap near $58 million, OIIM is trading substantially below likely liquidation value, and any recovery toward historic levels of EBIT would leave the firm trading at very attractive multiples, particularly after considering OIIM's $58.2 million in unrestricted cash.
Recognizing the secular decline in laptop sales, the company has recently been focusing investment on power management products targeted at the smartphone and tablet markets, along with a variety of products in LED general lighting, backlighting and battery management that should mitigate dependence on the laptop market going forward. The company has projected that recent manufacturing problems will continue to impact revenue through FY2015, with incorporation of recently-developed charger and power management products into tablet and notebook designs expected to result in revenue growth in the second half of the year.
Revenue in the latest quarter was $14.7 million, down 16% from 2Q2014 but up 12% on a sequential basis. Management has stated OIIM's cash-breakeven point is between $17.5 million up to $18.5 million in quarterly revenue, and their GAAP profitability-breakeven point is between $20 million to $21 million in quarterly revenue. Any eventual return toward historic EBIT profit margins would leave the company trading at extremely depressed multiples. With the involvement of activist shareholders as further described below, OIIM's cash-rich balance sheet and substantial additional non-core assets create a solid margin of safety, and could generate liquidation value exceeding the current share price in the event that a business turnaround fails to materialize.
Balance sheet and non-core assets
As of the recent 10Q the company had $58.2 million in unrestricted cash and short-term investments, or $2.24 per outstanding ADS. Additional current assets include $7.7 million of receivables (43 days sales outstanding, well within the historic range of 40 to 60 days) and $8.4 million inventory (101 days, turned over 3.6 times during Q2 2015). As of the end of June, the company had $66.8 million in working capital and tangible book value was $100.7 million, or $3.87 per outstanding ADS.
The company also owns real estate assets in Taiwan, Shanghai, and the California Bay Area which may have potentially understated value on the balance sheet. Management has estimated the total fair market value of its owned real estate at $25 million, approximately $5 million over the $20 million in value recognized on the balance sheet based on initial cost and depreciation. Importantly, a portion of its real estate is currently not being fully utilized in the business, and management has recently initiated plans to monetize some of its non-core real estate in Taiwan as more fully described below.
OIIM additionally owns minority equity stakes in several supply chain and manufacturing partners, part of which it is beginning to monetize. Management recently assessed the value of its long-term investments at approximately $10 million to $20 million. Reviewing the equity investments listed in OIIMs Form 7-F, the carrying value (at cost) of its three largest investments comes to approximately $15 million.
The majority of these investments are not publicly traded, making liquidation value difficult to assess, however the company did monetize part of its stake in ETrend during the year and is continuing to do so. The company also owns a 5% interest in a Singaporean management company called Philip Ventures Enterprise; half its stake was redeemed at cost during 2014, implying that its remaining stake may be monetizable for close to its carrying value of $497k. Assuming the company has taken appropriate writedowns to the value of impaired investments, managements estimated range of $10 million to $20 million value for long-term investments appears to be reasonable considering the approximately $15 million in carrying value following the partial sale of OIIMs stake in ETrend.
In the event of a successful turnaround, OIIM's business should have significant intrinsic value above the value of its cash, real estate and securities. Even before considering its cash holdings and resulting negative enterprise value, the current market cap of approximately $61 million represents a modest multiple to past peak EBIT of $23.4 million in FY2010 and $10.1 million in FY2011, and its price to sales ratio near 1 is a third to a half that of many comparable firms.
The company additionally owns a variety of intellectual property assets relating to power management systems that could be attractive to strategic acquirers, and could potentially generate some additional high-margin licensing revenues even with the company continuing as a going concern. If a successful turnaround in the business proves more difficult than anticipated, OIIMs solid cash-rich balance sheet and multiple real estate and equity assets could potentially generate well in excess of the current market cap in a potential sale or liquidation.
Management, shareholder activism, and capital allocation
Management has stated they are beginning to monetize non-core assets to maximize shareholder value, including specific plans to sell a portion of the real estate assets in Hsinchu, Taiwan, which is projected to result in a $2 million net increase to the firms net cash balance. During the third quarter, OIIM sold a portion of its minority stake in publicly-traded ETrend as mentioned above, and has stated they expect to sell the remaining shares in Q4 of this year.
Buybacks have already substantially reduced the diluted share count by over 1.1 million ADS equivalents over the past year, and the company is continuing the program, repurchasing 497,082 ADS units at a cost of $1.21 million during Q2 2015. Together with the ongoing monetization of non-core assets described above, further buybacks at a discount to net cash will continue to increase net cash value per outstanding share.
Officers and directors own 7% of the company, representing a significant enough stake to align management with the interests of long-term shareholders, while still leaving the company vulnerable to activism if the stock continues to trade at its current depressed multiples to likely liquidation value. In a Form 13-D filed earlier this year, noted value investor Jeffrey Eberwein of Lone Star Value Management declared a 5.7% ownership stake and laid out a plan for ongoing engagement with the Board and management to ensure shareholder value is maximized.
Importantly, Eberwein's 13-D ascribes significant additional value to the OIIM patent portfolio, and lays out a plan to engage with management and the Board in returning the firm to profitability, continuing to monetize non-core assets, and returning cash to shareholders through ongoing buybacks and potentially direct cash dividends.
Per recently filed 13-Gs, an additional 5.8% stake has been accumulated by Grandeur Peak Global Advisors, 9.6% is owned by DNB Asset Management, and 7.1% is owned by Renaissance Technologies. With activist involvement stimulating continued buybacks and cost control, OIIMs liquidation value should create a solid margin of safety, with the potential for substantial additional value if management can improve sales and margins toward historic levels.
continued accretive buybacks below NCAV per share
resolution of manufacturing difficulties enables a return to profitability by