This morning we advised you to take a position in Sigma Designs (SIGM) at $20. Only half a day later, it’s approaching $23, so far so good. We promised you a more comprehensive write-up. Here it is.
It is another very interesting story that involves a whole lot of shorting (where have we seen that before..). It was up 10% yesterday and we’re not happy with that, as this is one that came on our radar screen just recently, and it looks pretty interesting. First, look at this chart. Another beauty.
What do they do?
They have a raft of products that have to do with multimedia processing, like chips and software for Blue-ray players, internet-protocol television (IPTV) chips, and the like. They design the stuff, but do not produce chips, they’re ‘fabless’ (it does not have it’s own silicon wavers, outsourcing the actual production and concentrating on design of the chips and other stuff).
The IPTV market is especially interesting. It’s still in it’s infancy, but has a solid growth and it will grow a lot bigger. Sigma is especially well positioned in the high-definition (HD) part of this. The following quote from a research report by BWS:
IPTV subscriber trends continue to reflect a growing industry. AT&T (T- No Rating) added 148 thousand IPTV subscribers in the first quarter, while Chunghwa Telecom(CHT- No Rating) added 41 thousand new subscribers during the first quarter. UTStarcom (UTSI- Buy Rating) said their customers had over 800 thousand subscribers on UTSI network at the end of the first quarter, up by more than 50 thousand since the end of 2007.
AT&T is also the Company that setoff the collapse in SIGM shares due to inventory issues. The increase in subscriber additions was expected, and provides the basis to believe the inventory issue was a one-time event. AT&T averages three set-top boxes per subscriber.
The newer version of it’s IPTV chip should do well in two markets that are expected to grow aggressively, China and India. For instance, their 8654 processor is compatible with the Chinese Audio Video Standard (“AVS”), whilst that from an important competitor, STM microelectronics is not. The advantage may be temporary though, as the AVS standard might not survive as China Telecom does not use it.
What do we like
We like fabless. Producing chips needs scale, as it has become quite expensive (to say the least). It’s also a very specialist field. We like the economics of designing stuff. Once you have a cool design, reproducing it is cheap, and one can reap near monopoly profits until somebody else designs an even cooler thing. Which is actually what might have caused some of the problems, we’ll discuss this below.
Well, they’ve been taken to the cleaners, so to speak. For reasons that do not seem to warrant this kind of fire sale, and we also have a feeling that the shorts, who had quite a ball with this one, are now quietly covering.
They have a history of positive earnings surprises (comprehensively beating consensus forecast by analysts), which is always nice to see, especially if done serially. However, the last quarter actually contained a negative surprise. Perhaps those analyst didn’t want to be fooled yet again, or there might be something more serious at work. By the way, before we get too carried away, that negative earnings surprise was just 3%, a fraction of previous positive surprises. But still. It’s breaking a nice tradition. Does it point to fundamental problems? Not really.
It’s cheap, actually, it’s very cheap, trading at something like 8 times this year’s earnings (consensus estimate), although with yesterday’s and today’s (so far), the p/e is rising to 9.
Analyst invariably forecast good things. The lowest target on record is $25, which is still 20% above yesterday’s closing. The high target is a whopping $75, which is almost 4 times as much as yesterday’s closing.
Notwithstanding it’s selling insiders, the company itself might actually buy shares (perhaps an extra pay check for those poor overworked officials?)
What we don’t like
Insiders selling (although institutional investors bought almost 9 times as many in the same period)
Very high short interest
Unless there is a good explanation, this is not a good thing. But, as you realized if you stuck with us until here, we actually do not think there is.
It had three analyst downgrades on a row. However, this sits oddly with the price targets, the lowest of which is still 20% above yesterday’s close.
Their cool IPTV chip and Motorola
Here is a bit of news from Barrons yesterday:
Sigma Designs (SIGM) shares are rallying today on no news or analyst moves that I’ve found so far. The stock today is up $2.18, or 11.8%, to $20.61. SIGM has now rallied 32% since its massive one-day fall on April 15, after a negative research note on the company from Robert W. Baird analyst Tristan Gerra. Gerra’s note, which said rival Broadcom (BRCM) has won the right to provide chips to Motorola’s (MOT) second-generation IPTV set-top box for systems based on Microsoft’s (MSFT) Mediaroom platform, sent the stock to a one-day loss of $5.36, or 25.5%. It has now made up most of that decline
Very cool, that Sigma chip. But then came Broadcom, entering it’s turf. Motorola, a big producer of set-top boxes, and hence a big customer of Sigma’s chips, well, wouldn’t they like a second supplier, just to be in a little bit better position?
There is a well-known piece of economics, which is called the ‘hold-up’ problem, describing a situation in which one party makes transaction specific investments, only to be held up by it’s partner for a bigger share of the common spoils.
So there are sound economic reasons to have more than one supplier, although not positive news, we do not see it as terribly alarming and the fall from $70+ to $20 where we advised to buy this morning seems very overdone. If you don’t believe us, we’re far from the only ones, again from the BWS report:
“The second issue with the relationship at AT&T is from usage of a processor from Broadcom (BRCM- No Rating) in the new set-top boxes from Motorola (MOT- No Rating) due out in 2009. There has been no confirmation as to the level of extent BRCM would be used for AT&T. We do not believe SIGM is being replaced for investors to place a zero percent possibility of the Company achieving fiscal 2010 (Jan. 2010) estimates.
We continue to believe BRCM would serve as a secondary source of processors for MOT. Furthermore, the increase in subscribers by calendar 2009 should be enough to sustain a level of business without SIGM seeing a decline in revenues. Our theory is based upon the new SMP8654 processor being priced higher than the current market standard, the SMP8634 processor. The introduction of the new processor maintains SIGM’s leadership in high quality requirements for a high-definition IPTV settop box.”
Or, from another source:
“Broadcom’s entry into the field is not as big a catastrophe for Sigma as the share collapse suggests. Broadcom will not begin selling until 2009 and by that time the market will have grown to dimensions large enough to accommodate several chip suppliers, just like in any other niche. In addition, Sigma has a strong position in the market for the new Blu-ray disc format for DVDs, and it also recently began producing wireless chips for the digital home
At $19 a share, and assuming that just some of investment house UBS’s predictions for it in the coming years become reality, Sigma is a real bargain. UBS forecasts earnings per share of $2.20s for 2008, $3.17 for 2009, and $3.62 for 2010.”
This source also argues that the large short position is diminishing, which you can also see here