PDF SOLUTIONS INC PDFS
July 29, 2015 - 7:11pm EST by
SanQuinn
2015 2016
Price: 12.65 EPS .89 1.23
Shares Out. (in M): 32 P/E 0 0
Market Cap (in $M): 398 P/FCF 0 0
Net Debt (in $M): -132 EBIT 0 0
TEV ($): 266 TEV/EBIT 0 0

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Description

PDFS VIC
 
Thesis--
PDF Solutions (PDFS) is an underfollowed and unloved stock trading at $12.65/share with $4.15 in cash
and $.84 in ttm FCF/share ( EV/FCF= 10x). While this is attractive, based on expect cash balances at the end of
2016 investors can buy a business with a highly incentivized management team (CEO owns 8% of
company, all NEOs own 16%) for 4x consensus 2016 EBITDA. Additionally, PDF is in the early stages of
commercializing its technology in a new way (Design for Inspection) which represents a call option that
if successful would lead to a very significant increase in revenue and free cash flow. Alas, this seems too
good to be true, so you are right there is a catch--
 
PDF has missed 2 of the last 3 quarters, and has massive customer concentration issues with its top two
customers, GloFo and Samsung comprising ~80% of revenue. Despite these issues I believe PDFS
presents a compelling risk reward with downside protection based on the value of already contracted
royalty streams (Gainshare) over the next 5 years, significant cash balance, and intellectual property.
 
Overview
PDFS was founded in 1991 by CEO John Kibarian and Kimon Michaels. PDF Solutions helps fabless and
foundry semiconductor companies accelerate process development.
 
Design for Manufacturability (DFM).
DFM is PDF’s current core business model. Simply put PDF helps its foundry customers achieve higher
yields faster which is very important in the foundry business. PDF gets paid in two ways, through
consulting work (Design for silicon yield solutions) and on a per wafer royalty fee based on achieving
yield targets (Gainshare). Gainshare revenue is 100% gross margin revenue paid 1 quarter in arrears of
wafer production.
 
In the DFM business PDF signs 5-6 year contracts with foundry customers for specific nodes. In 2013
PDFS hit $26/share as Gainshare from 28nm started to ramp. In late 2014 PDF shares collapsed from the
low $20s to $12 upon news that Samsung had failed to sign a contract for 14nm production. Eventually
this contract was signed, and PDF shares rallied to $19, before falling back to $12 after reducing
guidance on the Q1’15 CC. Weakness at major customers (particularly GloFo) due to excess chip
inventory in the low end of the handset market and some movement of leading edge volume to
20nm/16nm/14nm led to the shortfall. While the DFM business model has significant earnings power as I
will discuss below, it suffers from customer concentration issues.
 
Design for Inspection (DFI)
DFI presents optionality to PDF shareholders. The idea here is that optical inspection and process control
have limitations at advanced nodes. There is unused space on chips and PDFS has a patent on using this
space for test structures. The technology provides measurements that can monitor the semiconductor
manufacturing process that in theory at should be superior to optical inspection. PDFS currently has
placed its test chips at several large fabless companies including QCOM. DFI is not currently producing
revenue, nor is the business model defined. That said, I believe it has the capacity to significantly expand
PDF’s customer base and revenue over time. Given the uncertainty around DFI, I am not putting
numbers around it, although it is safe to say that if successful it is a transformative development for PDF
and has the potential to make the stock worth multiples of the current price.
 
 
 
I believe 2016 is set up to be a good year for PDF’s core business for several reasons:
1) Ramp up of 14nm volume which should begin in Q4’15 and be incremental to existing 28nm
royalties
2) Backfill of 28nm volumes from trailing edge customers allowing a return of 28nm gainshare to
more normalized levels
3) Potential for PDFS customers to gain share of the AAPL A9 processor from TSMC a the 14/16nm
node
 
I believe that these factors should allow PDF to achieve consensus $50m in EBITDA in 2016 and factor
three could provide some potential upside to consensus.
 
Additionally, Kibarian has discussed a willingness to repurchase stock which could drive additional
shareholder value.
 
“We do expect to return cash to shareholders through the buyback that we did to
execute this quarter. We, from time to time, get closed out of those on blackouts, like we
did in the second half of 2014, due to the discussions we had ongoing with that customer.
But we would anticipate being able to increase our buyback levels should we not be locked
out on blackouts.” John Kibarian Q1’15 CC
 
 
While DFI and $50m in EBITDA in 2016 both sound great and should be enough to send the stock
meaningfully higher if successful, what risks does PDF’s customer concentration present? The good
news is that contracts at 28, 20, and 14nm are all signed and extend for 5-6 years. While it’s difficult to
model precisely, assuming PDF ends the year with $145m in cash and we assume that in a liquidation
scenario gainshare revenue over the next 6 years has a $125m present value after tax(compared to $44m in TTM gainshare revenue), and we attribute
zero value to PDF’s intellectual property and installed workforce of engineers (which I believe is actually
very valuable) there is ~30% downside risk to PDF shares. While this is a very theoretical exercise, the
point here is that in an end of the world scenario where PDF lost its two key customers at 10nm and
beyond, there would still be significant royalties for the next few years. Additionally, I believe that
Kibarian and the board would act in the best interests of shareholders and sell the company in that
scenario to monetize the value of the technology.
 
Downside
Cash on hand year end $145m
+ PV of Royalty stream $75-125m (They generated $44m in TTM gainshare, consensus is $60m for 2016)
+ Value of technology IP $50-100m
= $8.50- $11.75
 
Base Case
9x 2016 EBITDA = $18-20
 
Super Bull Case
DFI doubles royalty revenue, stock is a 2-4 bagger
 
 
 
 

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Volume production of 14nm at PDF customers

DFI milestone announcements 

Share repurchases 

 

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    Description

    PDFS VIC
     
    Thesis--
    PDF Solutions (PDFS) is an underfollowed and unloved stock trading at $12.65/share with $4.15 in cash
    and $.84 in ttm FCF/share ( EV/FCF= 10x). While this is attractive, based on expect cash balances at the end of
    2016 investors can buy a business with a highly incentivized management team (CEO owns 8% of
    company, all NEOs own 16%) for 4x consensus 2016 EBITDA. Additionally, PDF is in the early stages of
    commercializing its technology in a new way (Design for Inspection) which represents a call option that
    if successful would lead to a very significant increase in revenue and free cash flow. Alas, this seems too
    good to be true, so you are right there is a catch--
     
    PDF has missed 2 of the last 3 quarters, and has massive customer concentration issues with its top two
    customers, GloFo and Samsung comprising ~80% of revenue. Despite these issues I believe PDFS
    presents a compelling risk reward with downside protection based on the value of already contracted
    royalty streams (Gainshare) over the next 5 years, significant cash balance, and intellectual property.
     
    Overview
    PDFS was founded in 1991 by CEO John Kibarian and Kimon Michaels. PDF Solutions helps fabless and
    foundry semiconductor companies accelerate process development.
     
    Design for Manufacturability (DFM).
    DFM is PDF’s current core business model. Simply put PDF helps its foundry customers achieve higher
    yields faster which is very important in the foundry business. PDF gets paid in two ways, through
    consulting work (Design for silicon yield solutions) and on a per wafer royalty fee based on achieving
    yield targets (Gainshare). Gainshare revenue is 100% gross margin revenue paid 1 quarter in arrears of
    wafer production.
     
    In the DFM business PDF signs 5-6 year contracts with foundry customers for specific nodes. In 2013
    PDFS hit $26/share as Gainshare from 28nm started to ramp. In late 2014 PDF shares collapsed from the
    low $20s to $12 upon news that Samsung had failed to sign a contract for 14nm production. Eventually
    this contract was signed, and PDF shares rallied to $19, before falling back to $12 after reducing
    guidance on the Q1’15 CC. Weakness at major customers (particularly GloFo) due to excess chip
    inventory in the low end of the handset market and some movement of leading edge volume to
    20nm/16nm/14nm led to the shortfall. While the DFM business model has significant earnings power as I
    will discuss below, it suffers from customer concentration issues.
     
    Design for Inspection (DFI)
    DFI presents optionality to PDF shareholders. The idea here is that optical inspection and process control
    have limitations at advanced nodes. There is unused space on chips and PDFS has a patent on using this
    space for test structures. The technology provides measurements that can monitor the semiconductor
    manufacturing process that in theory at should be superior to optical inspection. PDFS currently has
    placed its test chips at several large fabless companies including QCOM. DFI is not currently producing
    revenue, nor is the business model defined. That said, I believe it has the capacity to significantly expand
    PDF’s customer base and revenue over time. Given the uncertainty around DFI, I am not putting
    numbers around it, although it is safe to say that if successful it is a transformative development for PDF
    and has the potential to make the stock worth multiples of the current price.
     
     
     
    I believe 2016 is set up to be a good year for PDF’s core business for several reasons:
    1) Ramp up of 14nm volume which should begin in Q4’15 and be incremental to existing 28nm
    royalties
    2) Backfill of 28nm volumes from trailing edge customers allowing a return of 28nm gainshare to
    more normalized levels
    3) Potential for PDFS customers to gain share of the AAPL A9 processor from TSMC a the 14/16nm
    node
     
    I believe that these factors should allow PDF to achieve consensus $50m in EBITDA in 2016 and factor
    three could provide some potential upside to consensus.
     
    Additionally, Kibarian has discussed a willingness to repurchase stock which could drive additional
    shareholder value.
     
    “We do expect to return cash to shareholders through the buyback that we did to
    execute this quarter. We, from time to time, get closed out of those on blackouts, like we
    did in the second half of 2014, due to the discussions we had ongoing with that customer.
    But we would anticipate being able to increase our buyback levels should we not be locked
    out on blackouts.” John Kibarian Q1’15 CC
     
     
    While DFI and $50m in EBITDA in 2016 both sound great and should be enough to send the stock
    meaningfully higher if successful, what risks does PDF’s customer concentration present? The good
    news is that contracts at 28, 20, and 14nm are all signed and extend for 5-6 years. While it’s difficult to
    model precisely, assuming PDF ends the year with $145m in cash and we assume that in a liquidation
    scenario gainshare revenue over the next 6 years has a $125m present value after tax(compared to $44m in TTM gainshare revenue), and we attribute
    zero value to PDF’s intellectual property and installed workforce of engineers (which I believe is actually
    very valuable) there is ~30% downside risk to PDF shares. While this is a very theoretical exercise, the
    point here is that in an end of the world scenario where PDF lost its two key customers at 10nm and
    beyond, there would still be significant royalties for the next few years. Additionally, I believe that
    Kibarian and the board would act in the best interests of shareholders and sell the company in that
    scenario to monetize the value of the technology.
     
    Downside
    Cash on hand year end $145m
    + PV of Royalty stream $75-125m (They generated $44m in TTM gainshare, consensus is $60m for 2016)
    + Value of technology IP $50-100m
    = $8.50- $11.75
     
    Base Case
    9x 2016 EBITDA = $18-20
     
    Super Bull Case
    DFI doubles royalty revenue, stock is a 2-4 bagger
     
     
     
     

     

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    Volume production of 14nm at PDF customers

    DFI milestone announcements 

    Share repurchases 

     

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