Saturday, June 25, 2011

An Interesting Net-Net Opportunity

Action Semiconductors (ACTS) has been a perennial net-net since 2009. I started looking at it during the 2008-09 crises because the company was trading at 50 cents for a dollar. Here is the link to the article when I first looked at it Getting started - ACT(S)

Since the crises the company’s price almost doubled in 2010 and the significant margin of safety went away. However, with the recent spate of fraud (or potential fraud) in Chinese stocks, there is nervousness surrounding all Chinese stocks and ACTS (though not a Chinese stock but has most of its operation in China) has also suffered as a result.

I decided to take a re-look at the stock to see if the stock is appealing at current prices.

Company Background

ACTS is fabless semiconductor company that engages primarily in the businesses of designing, developing and marketing SoCs (Systems-on-a-Chip), for portable media players. ACTS primarily designs these chips but outsources manufacturing of all its products to third party contractors - He Jian, and United Microelectronics Corporation. ACTS provide these contract manufacturers monthly targets and thus retain lot of flexibility around what needs to BE produced. This allows company to have limited capital expenditure for manufacturing but also limited need to have a lot of inventory on their books. Company also uses independent vendors to help with testing and packaging functions depending on capacity constraints. 

Company sells most of its products to value added distributors or contract manufacturers. Thus the company doesn’t have a lot of brand recognition.

Company Financials

The company was listed in November 2005 on Nasdaq through an IPO. In that respect it differs from many of the Chinese company which were created through reverse mergers. Company has also used Deloitte as its auditor for a long time which gives me added comfort. Without the above 2, I would not be looking at any Chinese company (this is actually based out of Cayman island).

I have used annual reports for the 5 full years (2006-2010) and extrapolated the numbers from the 1st quarter of 2011 for 2011. 

  • I have assumed that 2011 numbers will be four times of what has been observed in the 1st quarter so far.
  • MV has been derived by looking at the dilution share count at the end of period and multiplying by the market price at the end of the period.
  • EV is MV – liquid current assets (there is no debt)

A few key things stand out:
  • Revenue of the firm has shrunk dramatically over the last 5 years to 25% of what it did in 2006.
  • Market value of the company has followed suit as well.
  • This has resulted in Enterprise Value of the company becoming negative. It has been negative over the last 3 years. I actually looked at it in Feb 2009 (Getting started - ACT(S)) when things were looking quite bleak.

It is the negative Enterprise Value or “Net-Net” aspect that got me excited then and that gets me excited now as well.

To better understand the value in the stock let us look at the Balance Sheet.

Balance Sheet

A few things stand out from looking at the balance sheet:
  • Company has increasingly put Cash to work into Marketable Securities to earn interest income (Q1 2011 seems to be an aberration).
  • Liquid current assets has not changed much over the last 5 years, though it has gone down significantly since end of 2008.
  • If the company were to be liquidated today the owners will get a 35% jump in value. This valuation is a very conservative valuation because I have excluded all assets which are not liquid. However, I have included all liabilities when coming up with Liquidation value.

Qualitative Factor

  • ACTS had a change of guard last year with Niccolo coming as CEO in place of Nan-Horng. Niccolo is much more focused on Research and is aggressively building that team. The first result of that effort will be seen later in the year when their series 27 and series 28 products hit the tablet market. 
  • ACTS has been recently tied up with MIPS Technologies to bring Honeycomb (Android 3) to the MIPS architecture. It is the first positive news from ACTS in a long time.  
  • ACTS has also been investing heavily in the recent past. This is reflected in the reduction in Liquidation value in the last quarter.

  • ACTS is trading at a significant discount to its cash value. This is reflected in the fact that if the firm were to liquidated today it will provide at least 35% return to its current holders.
  • ACTS recently had good trial runs of its Series 27 and 28 products. These series are now moving in production and the tangible results of those should show up in the 2nd half of the year. It also recently tied up to support Android 3 on Tablet.
  • The best part of buying ACTS is that you are not paying anything for the future. If things work out there is a significant upside. If they don’t there is still upside with the liquidation value. I prefer these type of situations J

Disclosure: I currently own ACTS.

Disclaimer: All views expressed in this article are the author’s own views. They don’t represent the views of any company or organization that the author may be affiliated with. This is not a recommendation to buy or sell a stock. You need to do your own diligence before buying or selling a stock.

Sunday, June 19, 2011

HP (Hewlett Packard) – Story of Hidden Pearls?

HP is the quintessential Information Technology Company. It has presence in multiple segments and is a great barometer of the tech spending. Its stock is also down significantly over the last year and in that aspect also it is a great representative of what is happening with big IT companies.

In the recent past it has gone through multiple changes including change of CEO – Mark Hurd to Leo Apotheker, reduction in revenue/earnings guidance and leakage of confidential memos from CEO. These are the things that you wouldn’t expect from a company which is consistently making money and which has performed well during the 2008-2009 crisis. All of the above has caused the stock price of the company to come down by more than 20% over the last year. The financial statistics of the company seemed appealing enough for me to take a deeper look.

Company Structure

Company is organized into the following key business segments:
  •          Services
  •          Enterprise Storage and Servers (ESS)
  •          HP Software
  •          Personal Systems Group (PSG)
  •          Imaging and Printing Group (IPG)
  •          HP Financial Services (HPFS)

Some segments like Services and Printing Group are more stable. The earnings and revenues come from long term contract and hence the revenues are more stable and margins higher. On the other end of the spectrum is PSG. HP is the market leader in selling PCs, Notebooks and handheld devices to both corporate and individual customers. However, PSG is an extremely competitive segment. Hence the revenue can have variability and the margins are lower. Others fall in between.

Below table provides the breakdown of Revenue and Profit by various segments.

Another interesting factor to look at is how these business segment revenues have changed YoY. 

So overall the businesses held up quite well during the 2008-2009 crises. Infact, the services business grew as companies looked to reduce the expenses and outsource more technology work.

The above fact gives me the comfort that in adverse market situations the company should be able to ride out of the crises given its diversity of businesses. Next let us look at the valuation of the company.


I have used annual reports for the 4 full years (2007-2010) and extrapolated the numbers from the 1st half of 2011 for 2011. This 5 year period is quite representative of the company’s performance since it includes the 2008-9 crises.

  • I have assumed that 2011 numbers will be double of what has been observed in the 1st half so far.
  • Annual Growth is derived as annual compounding over the 5 year period.
  • MV has been derived by looking at the dilution share count at the end of period and multiplying by the market price at the end of the period.
  • EV is MV + s-t debt + l-t debt – cash – s-t investments

A few key things stand out:
  •      Revenue and Profit (PAT) have grown at roughly the same pace 3.8% over the period. So HP has been able to keep the profit margin relatively constant.
  •            MV has fallen -6.5% annually. A portion of this is because of the aggressive buy back that HP has embarked on over the last few years (more on this later). So while the share price wouldn’t have fallen by this %, because the share count has reduced, the MV has come down.
  •             EV has not fallen as much. It has gone down by -4.9% annually which means that company has been leveraging up over this period. Lastly the BV has not moved much over the last few years again because of the share buy-back.
  •        Finally, Valuation metrics looks very interesting.

o   P/E has come down to 7.8 currently from 19 at end of 2007.
o   EV/PBIT has come down to 6.8 from 15.5

HP has not been this cheap on the above metrics even during the 2008-09 crises.

We can safely surmise that HP is a cheap stock. But is it a value stock?

To understand this better let us look at the cash flow from HP over this period and how the company has used the Cash flow.

Cash Flow

When I look at Cash Flow, I am most interested in Owner’s Earnings or Owner’s Cash Flow. This is the cash flow that is available to the shareholders of the company to be used for distribution of dividends, repurchase of shares or to act as buffer during crises.

As can be seen from the above, HP has been a prodigious source of Operating Cash Flow – an average of 12.5 BN $ in a year. However, it is also a prodigious user of Cash, having spent more than 8Bn $ a year on Capital Expenditure and Acquisitions. Thus the average cash flow available in a year is only 4.5Bn $. For a company that is worth 86Bn $ of Enterprise Value, the return 4.5/86 = 5.23% is not appealing.

However, once you take away the acquisitions like year 2009 or year 2011 so far, the cash flow available to the shareholders become a lot more appealing. It generates around 10BN $ of Cash flow. Then the return is 10/86 = 11.6% is a lot more appealing.

Hence, if HP can tone down its acquisition spree that it has been on for the last 4 years, the stock can provide great return. Leo has also publicly stated that he is not looking to do any big acquisition. Whether he will be able to resist the temptation of doing acquisitions remains to be seen.

Lastly, let us look at how it has used the Cash flow that it has generated – 21BN $ over the last 5 years.

Usage of Cash Flow

HP has been a good steward of FCF that it has not spent on acquisitions. It has returned all of it in the form of stock repurchase which is an efficient medium of utilizing the cash. Here is a summary of how the Cash flow has been used.

Qualitative Factor
  •           HP had a change of guard with Leo Apotheker coming in place of Mark Hurd. From the various presentations that I have seen, Leo is quite focused on generating shareholder value which is a good sign.
  •      Recent management changes – reducing the hierarchy, increasing responsibility of key executives and bringing new blood should help reinvigorate the organization.

However, I don’t have enough data points to be absolutely sure on this front. So far based on everything that I have seen this area doesn’t seem to be a concern. This is also nothing to write about for the same reason. H business
ence this section is small.

  •       HP is a very stable and solid that has been able to keep its profit margin over the last 5 years.
  •            HP is currently trading at a cheap valuation compared to the historical norms as well as the valuation during the 2008-09 crises.
  •          HP has spent a lot of money on acquisitions over the last 4-5 years. If HP can reign in its acquisition spree (or do acquisitions where it is getting as much in return for the price it is paying), this is a great opportunity to enter the stock.

Disclosure: I recently nibbled at HP stock. As there is more clarity regarding HP acquisition strategy or as the stock gets cheaper I will look to increase the position.

Disclaimer: All views expressed in this article are the author’s own views. They don’t represent the views of any company or organization that the author may be affiliated with. This is not a recommendation to buy or sell a stock. You need to do your own diligence before buying or selling a stock.

Saturday, June 11, 2011

Berkshire Hathaway

Historical Perspective

Warren Buffett has led Berkshire Hathaway since 1965. In that period of 45 years, Warren has grown the book value of the firm by 20.2%. Market value of Berkshire has grown at close to book value. Over the last 20 years, Berkshire book value has grown by 22.25 times – an annual compounding of 16.8%. The market value has grown by 16.42 times – an annual compounding of 15%. How many companies or fund managers can match that.

The above also brings us to the opportunity in Berkshire. For the longest period, Berkshire was way over the book value because of Buffett premium. Over the last 20 years that premium has shrunk. This coupled with a few one-off events like Underwriting losses (expected) in 2011, Sokol-gate and market idiosyncrasies now provides us some fantastic opportunity to start a position in Berkshire. Below are 2 ways to value Berkshire.

Approach 1

Current price/share is 111,045 $. Thus the discount is 22%

·         Above approach counts the $66 Bn of float as part of investments/share with the expectation that the float will remain stable over the years (ideally, it will grow).

·         I have used pre-tax earnings multiplier of 8 for Berkshire vs 10.5 for S&P 500 (PE is around 15 for S&P 500. Assuming 30% tax rate, pre-tax earnings multiplier is 10.5).
Approach 2

Current price/share is 111,045 $. Thus the discount is 18%

·         Exclude the $66 Bn of float as part of investments/share.

·         Assume 10% return on the float (vs more than 20% ROI that Warren has produced during his career).

·         We are not accounting for any growth in float over time.

·         I have used pre-tax earnings multiplier of 8 for Berkshire vs 10.5 for S&P 500 (PE is around 15 for S&P 500. Assuming 30% tax rate, pre-tax earnings multiplier is 10.5).


With very conservative assumptions above for both approaches 1 and 2, we still get a discount of 20% for Berkshire. Thus we have a small margin of safety for Berkshire investment. Now let us look at the qualitative factors for Berkshire.

Qualitative Factors

Qualitative factors are a key ingredient to how the investment works out in the long term. Some of the key ones that I consider are:
·         Management: This is one of the best aspects about Berkshire. Warren has been running Berkshire for 45 years and he is the best management-owner one  can hope to get. He always considers the return on investment before making any investment. He judges himself by that yardstick and that is one of the reason Berkshire has done so well.

·         Culture: Berkshire culture is very long term oriented. This allows them to be patient when markets are not favorable. This allows them to make logical decisions without getting pressured into what the street is thinking or what their competitors are doing.

·         Unique businesses: Berkshire has collected an eclectic mix of businesses that have unique competitive advantages. This allows them to handle down markets relatively well. It also allows the businesses not to be as impacted by the market competition thus preserving profitability.


·         Berkshire is currently trading at 20% below the intrinsic value.

·         Berkshire has the some of the best qualitative factors. This allows the investor to be very comfortable and not have to worry about short term improvements.
·         This is a phenomenal opportunity to invest in one of the best businesses available and where the business is selling at a discount with very limited downside risk.

Disclosure: Long Berkshire. Looking to increase position on dips.