TOWER SEMICONDUCTOR LTD TSEM
November 22, 2014 - 3:46pm EST by
moneyball
2014 2015
Price: 11.95 EPS 1.86 3.00
Shares Out. (in M): 75 P/E 6.4 4
Market Cap (in $M): 896 P/FCF NA 3
Net Debt (in $M): 145 EBIT 147 235
TEV ($): 1,041 TEV/EBIT 7.1 4.4

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  • Semiconductor
  • Turnaround
  • Orphan stock
  • Discount to Peers

Description

 

The best stocks have an investment thesis that is simple and easy to understand.

TowerJazz Semiconductor is extremely undervalued. It has a 4x P/E based on my 2015 EPS relative to its Asian peers that trade at a 15x P/E.  Earnings per share are expected to grow over 50% in 2015 and will likely beat the Wall Street consensus by 15%.   I wish that I could fill an equity portfolio exclusively with stocks that have these metrics. As the company reports these excellent financial results in 2015, the stock could double or triple.

 

 

Company Description And History:  A 20 Year Turnaround

Tower is the #1 specialty semiconductor foundry in the world,  focused on the analog market.

The $1 Billion sales mix should be as follows in 2015:

45% sales to Panasonic in Japan via a 5 year guaranteed purchase contract in a 51%/49% Joint venture

25% sales to RF producers such as Skyworks or Triquint

15% TOPS sales to (IDMs) integrated device manufacturers that outsource some of their production

10% sales for CMOS

5% sales for Power applications

2 fabs in Israel and 1 in the USA are 100% owned and generate 55% of company sales.

 

The company has a disastrous history and should have gone bankrupt.  Originally the company purchased  a semiconductor factory from National Semiconductor in 1995 that tried to compete with Taiwan Semiconductor as a foundry and failed. The company lacked scale with only $100 million in sales, did not have the cash to invest in leading edge technology like TSMC, and had only 1 fab in a geopolitically risky country, Israel.  Along the way Tower accumulated over $1 Billion in net operating losses.  Tower survived because the government of Israel decided that having a local semiconductor fab was essential to nurturing a technology industry.

 

Finally in 2014 Tower is beginning to flourish as a semiconductor foundry by carving out a niche. The company is focused on analog semiconductors, a market that is too small to matter to Taiwan Semiconductor (TSMC). After the acquisition of Jazz in 2008 and a joint venture with Panasonic in 2014, Tower is now geographically diversified with 6 semiconductors factories in three countries (Japan, USA and Israel).  The corporate culture at Tower under the leadership of its CEO Russell Ellwanger has also shifted from being focused on R&D to profit maximization. 

 

Positives:

 

 

Undervalued Stock Based on P/E, EBITDA and Free Cash Flow

 

 Foundry Companies Peer Group                
 Consensus Estimates below     FY    FY  2015     
    Stock   2015 2015   2015

 Free Cash

   
 Company  Ticker  Price EPS  P/E  EV/EBITDA  Flow    
 Advanced Semiconductor  ASX  2.60  0.23  11.3  NA      
 Semiconductor Manufacturing  SMI  11.90  0.52  22.9  6.0      
 Taiwan Semiconductor TSM  2.60  0.17  15.3  7.8      
 United Microelectronics  UMC  22.00  1.69  13.0  3.9      
AVERAGE   -->        15.6        
 Tower Semiconductor  TSEM  11.95  2.60  4.6  5.4  3.60    

 

 

 

 

 

 

India Construction Contract To Add $0.50 EPS to 2015 EPS

The government of India has decided that they would like to start a semiconductor industry in their country. The first factory will cost $5 Billion, but the country has no local expertise. They decided that an expert general contractor to oversee the construction was necessary. Tower Semiconductor was selected and will be paid about $60 million annually for several years to build the new fab. The final government approvals are expected in December and then construction will begin. This contract will earn over $0.50 EPS/year and is the primary reason for my EPS estimates being 15% above the 2015 consensus.

 

Panasonic Joint Venture Could add $1.00 EPS over the next 5 years

Panasonic is a massive Japanese conglomerate that is undergoing a comprehensive restructuring. They decided to spin-off their 3 semiconductor factories in a 51%/49% Tower/Panasonic joint venture in March 2014. This deal is unbelievable. Tower paid nothing to acquire a 51% equity stake in this venture. Panasonic guaranteed that they will purchase $400 million annually in semiconductors for the next 5 years from these factories that will cover the fixed costs. The factories are under-utilized and have the room to generate $500 million in additional annual sales. Foundries have very high operating leverage and Tower expects 60% operating margins or potentially $300 million in profit from these factories. If you assume a 33% tax rate,  a 51% equity stake, and 100 million shares,  your calculator will show the $1.00 EPS potential. Six months after the venture started, Tower has already signed contracts with new customers that will generate $140 million per year in non-Panasonic sales.

The Japanese Yen has depreciated over 13% versus the Dollar in the past few months as a result of the renewed quantitative easing efforts in Japan.  This makes the Panasonic JV an even lower cost foundry option versus the Taiwanese fabs that are linked to the US Dollar.  

   

One of the assets in the JV is a brand new 300 mm fab that would cost $2 Billion or $20/share to build.  What a gift!

 

 

Free Cash Flow Exceeds EPS by $1.00/share in 2015

One of the primary benefits of the Tower foundry model versus its peers in Taiwan is that it requires less cash. Tower spends 10% of sales on capital expenditures versus 20-25% of sales at peers such as UMC and TSMC. In 2015 Tower will report depreciation and amortization of $180 million and $100 million in cap ex. With customers paying their bills promptly in 40 days and suppliers being paid at a slower pace of 100 days, Tower does not have any challenges with working capital.

 

Explanation For Why Tower Semiconductor Is Undervalued:

Nearly all shareholders in Tower have lost money over the past 20 years and gave up on the company. Take a look at the 20 year stock chart.  What suffering!  

Tower is an orphan stock. Most independent public foundries are located in Taiwan and the Wall Street analysts that cover them are based in Hong Kong. Tower is an oddball with a corporate headquarters in Israel and a stock that is listed in New York. As of today no foundry analyst publishes research on Tower. 

As a result none of the major mutual fund firms (Fidelity, Wellington, Capital Guardian) own Tower, not even their Technology focused funds.

The historical financial performance is miserable so few quantitative screens until recently are going to highlight Tower as an attractive investment. 

 

RISKS:

  1. In 2014 Tower still earns about 40% of its profits from fabs located in Israel. The Iranian backed terrorist group Hezbollah, is based in Lebanon. They claim to have an arsenal of 50,000 missiles that are directed at Israel. A war and the uncertainty created by the conflict would cause the stock price of Tower Semiconductor to fall.
  2. Tower supplies $50 million in frontal module switches to RF vendors such as Skyworks and RF Micro. Recent design wins are resulting in Tower taking material market share from IBM that could add $100-$200 million in additional annual sales. In October Global Foundries agreed to acquire the IBM foundries based in New York and invest aggressively in the facilities. There is a risk that some of the recent design wins could remain at IBM now that they have a new owner that is committed to the business. Meanwhile the RF industry is experiencing phenomenal growth. The combined year over year sales growth at RF Micro, Skyworks, Triquint, and Avago has increased over 50% in the past year. 
  3. The semiconductor foundry business is economically sensitive and has very high operating leverage. In a severe global recession Tower sales would decline and the decline in profits would be magnified. 
  4. Tower is the sole source provider of semiconductors to most of its customers. This places Tower in a stronger bargaining position with its customers. At some point more customers might decide to multi-source their semiconductor needs resulting in lost sales for Tower. 
I 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

Each quarterly press release should highlight excellent financial results at Tower.

Wall Street research coverage by additional firms will increase investor awareness about Tower Semiconductor.

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