Ellipsiz @ 68 cts ( Semiconductors / Singapore ) 2 comments
Final Poll Results: 7:5
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1.Doubts about immediate impact of K&S acquisition
2.17X ex-extraordinary item PE not exactly cheap
Having seen the high target prices set by DBS Vickers in late August ($1.10) and Kim Eng earlier this week ($1.05) I decided to take a closer look at Ellipsiz. And after looking through the relevant documents, I am rather mortified.
First, the growth drivers. Ellipsiz is a semiconductor services provider, and has three business segments – Fabless Solutions, Wafer Fab Solutions, and Manufacturing Test Solutions. These may also be classified as upstream (design), midstream(manufacturing) and downstream(quality and packaging) respectively. According to the analysts and corroborated by the segmental composition over the last few years, Fabless Solutions is the growth driver for the coming years, growing from nothing in FY04 to form 44% of the revenue pie in FY06, while the other two segments shrink in importance (particularly Wafer Fab Solutions). The optimism is no doubt generated by the acquisition of Kulicke & Soffa's probe card/wafer test assets in early 2006, an acquisition which Ellipsiz has been trumpeting now makes it the third largest probe card company in the world.
The projections are that company topline are expected to grow >40% in the coming FY07. Ever wonder why bottomline is less often mentioned? That should be a danger sign that all investors should note. The answer lies in the Kulicke and Soffa annual report for 2005. K&S has been making losses in two of its last three financial years (September being year-end), including the most recent FY05, and the drag has consistently been its Test segment, which "contributed" US$27M, US$21M, US$142M of losses respectively in FY03, FY04 and FY05 (note that FY05's huge losses were partly due to intangible asset/goodwill impairment charges of ~US$101M). The Test segment is where the probe card assets recently bought by Ellipsiz come from. To be fair, the probe card assets bought by Ellipsiz are but one part of the Test segment of K&S (they might even be profitable among the sea of red in the Test segment), but in the absence of further details one has to exercise extreme caution, especially when K&S's Test segment assets were so heavily written down (ie. deemed as less income-generative than originally planned) in FY05.
There are mergers that work and mergers that don't. A significant one recently in the same industry is STATS which had to spend about two years to digest its CHIPs. The integration process may be easier if the acquiring company is significantly larger than the acquiree. In this case, note that the newly acquired probe card assets of K&S generated US$65M sales in 2004, as compared to Ellipsiz's probe card division's (SV Probes) US$20M.
Next, let's check out Ellipsiz's financial statements. Although the FY06 profits looked great, note that about S$23M was due to extraordinary income from financial asset disposal gain ($10M) and negative goodwill from acquisitions, mainly K&S's probe card assets ($13M --- and it's not even tangible!). Also note that these extraordinary gains were all done in 2H06, which means exclusion of these extraordinary items reduces 2H06 profits to $5M, as compared with $8.6M in 1H06 (before the acquisition). Although the K&S acquisition has contributed $33M sales for 4 months of operation, it probably has also a similar impact on the P&L --- albeit negatively. Valuation-wise, ex-extraordinary items, full-year EPS is about 4 cents, which means FY06 PE is about 17 times. Kim Eng has a peer valuation comparison where it lists global peers in the probe card segment, wafer reclaim segment and distribution segment as trading at between 15-25X PE while Ellipsiz, with all the non-recurring FY06 gains, is trading at 6X --- a rather unashamed comparison if there ever was any. At the same time, they also forecast a ~45% pre-tax profit (ex-extraordinary) year-on-year growth in FY07, in proportion with a ~45% topline growth ie. margins are maintained.
It will be quite a miracle if the acquisitions can be digested so well that operating margins are maintained in FY07. As shown in the results for 2H06, there was already a post-acquisition impact. Technology often leaves people bedazzled, and the analyst and company reports are often full of market claims and technical terms that have a "shock and awe" effect on the reader. At the end of the day, what matters are the numbers --- and properly adjusted ones at that.
(1) Kulicke & Soffa Annual Report 2005
I agree that Ellipsiz is a hot-stock-not: Yes/No