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Chips Have 2-Sides
At first glance, the metrics appear grim for investors in Magnachip Semiconductor Corp (NYSE:MX). This 40-year-old, South Korea-based designer and manufacturer of analog and mixed-signal semiconductors for communications, IoT, consumer, industrial, and automotive applications deserves the Sell Quant Rating from Seeking Alpha. However, there is another side to consider and those opportunities have us leaning to a Hold assessment, at this time.
Before we delineate the negatives– sentiment, risks, headwinds, and valuation– we think there are several opportunities for the stock to climb in price. But a Hold assessment for retail value investors is an enormous gamble. We disagree with S A and Wall Street analysts rating the stock a Buy and Strong Buy respectively.
Risks
The foremost risk to retail value investors is that we do not see any particular catalyst sparking a share price unless there is talk about a takeover, as in the past. Revenue is going to be less in FY ’23 with the shutdown of the Transitional Foundry Services segment, gross profit is going to remain below the industry average, and peers and the company’s hoard of cash is at risk if it net operating income continues in the red and management pursues its aggressive share buyback strategy.
Forward, further reductions in force management initiated in 2023 and cuts in the C-suite will have to be made to get the numbers into the black. Magnachip must spend more of its cash hoard and borrow money to launch and market its two new businesses.
There are many other risks for retail value investors to consider the company details in its USSEC filings that investors ought to read before making any decision. Pages 18 through 34 go well beyond boilerplate listings of risks.
We are highlighting other risk factors of immediate concern: low sentiment generating a near-failing grade in momentum, F Factor Grade for growth despite management’s forecast of +9% in FY ’24, and severe headwinds from political conditions contributing to our Sell assessment; they are no less important considerations than the financial status.
Sentiment
The Seeking Alpha Quant Rating waivers between Sell to Strong Sell. For 6-months, the standing was a Hold assessment. This week, the Quant Rating upped from a Strong Sell to Sell assessment leaning in the direction of Hold.
S A maintains its Warning signal that the company “is at high risk of performing badly.” Fintel and other media reports support the negative sentiment. Magnachip’s Q4 ’23 financial statement and earnings call transcript of February 28 exacerbated the situation. The stuck-in-the-mud Factor Grades changed little in 18 months contributing to the negative sentiment.
Quant Rating & Factor Grades (Seeking Alpha)
Cascading Revenue and Threats
Cascading revenue and other threats add more risk to investing in Magnachip. Q3 ’23 revenue fell -16.7% Y/Y, and FY ’23 revenue and gross profits tumbled -31.9% and -760 bps Y/Y, respectively. Management’s declaration to shareholders that “revenue for full year 2024 (is) to remain relatively flat to slightly up…” does not inspire much confidence. Continuing inflation will add to lower profits. In contrast to Magnachip stock moves, our favorite semiconductor ETFs are:
YTD….. +14.7% YTD….. +25.5% YTD….. -25.6%
1-YEAR.. +58.6% 1-YEAR.. +79.4% 1-YEAR..-38.55%
5-YEAR…+259% 5-YEAR…+330.6% 5-YEAR…-26%
Furthermore, forecasts are brightening for the semiconductor industry’s growth and profitability. Deloitte foresees a +13% in ’24 revenue over ’23 which was only +2.5% higher than 2022, but Magnachip cannot keep pace.
We were cautiously conservative in our assessment of Magnachip’s investment future last July. Management’s bet “creating two main business entities to better align our product strategies… MSS, mixed-signal solutions which include display and Power IC produces and PAS, power analog solutions…” will take time and money to have any financial impact. In sum per the company,
Q4 combined R&D and SG&A was $27.5 million. (T)his compares to R&D and SG&A of $23.7 million in Q3 2023, and $26.2 million in Q4 last year. R&D in Q4 was $15.4 million as compared to $11.6 million in Q3 and $13.7 million in Q4 last year due to higher masks that cost. Stock compensation charges including operating expenses were $1.7 million in Q4 compared to $2.1 million in Q3 and $1.5 million in Q4 last year. Q4 operating loss was $15.9 million. This compared to an operating loss of $9.2 million in Q3 and operating loss of $10.1 million in Q4 2022. On a non-GAAP basis, Q4 adjusted operating loss was $14.1 million compared to adjusting operating loss of $7.1 million in Q3 and $8.6 million in Q4 last year. Net loss in Q4 was $6 million as compared with a net loss of $1.2 million in Q3 and a net income of $3 million in Q4 last year. Q4 adjusted EBITDA was negative $10 million. This compares to a negative $2.7 million in Q3 and negative $4.8 million in Q4 last year.
Threats
Magnachip’s gross margin is historically woeful. The industry’s average gross margin hit between 43% and over 44% of revenue each of the last two years, whereas we calculate Magnachip’s g. p. average over the past 8 years is about 26.18% of revenue. Netcial’s study of gross profits offers this comparison
GP Comparison MX & Peers (Netcial.com)
Management blames the low g p partly on low margins from its Transitional Foundry Services segment. Its Power-Analog Solutions segment is doing much better; however, we foresee from what we read and hear from Magnachip’s management that the g p margin will be struggling this year due to higher costs for labor and materials to produce better revenue in China.
We forecast a further decline in FY ’24 earnings even if revenue increases as smartphone and China’s auto sales rebound. For the sake of brevity, here are just several reasons:
- Apblive.com reports India is making “giant leaps towards becoming a semiconductor hub… monopolized by East Asian giants like China, Taiwan, Korea, etc.”
- Magnachip’s largest and ferocious Korea-based competitor is launching AI chip-powered display and wireless projector business.
- The company is out of the low-margin Transitional Foundry Services business. That industry segment is growing at a CAGR of over 7% annually but was a management burden for Magnachip. Intel is transitioning its business plan to move heavily into the foundry business and its stock is +15% over the last year. Tanking this segment can translate to an over 6% decline in Magnachip’s EPS.
- About two years earlier, China’s public policy changed amid trade tensions in the microchip war when America began extorting (our words) allies to join in export controls on chips and technology to China. China’s official response has been multifold but, most importantly, China backlashed by investing in the R&D semiconductor and processing tech segment and its domestic foundry and sales industry. China wants to achieve self-sufficiency. Politically, Bloomberg claims the CCP issued a directive this week that China’s EV makers buy local chips. That can spread to smartphones. “De-Americanize” is how the New York Times describes the recent policy moves by China.
- There is risk in a handful of investors who own a majority of the voting stock. Though they are in a purchasing mode that contributes to the share price moving from $5.18 to nearly $5.60 per share, any significant challenges can push institutions to sell shares; price sensitivity can just as quickly hammer the share price. One day in February after the earnings miss, financial news headlines reported the stories using powerful words like “MX shares are getting obliterated today.” Paul Triolo recently published an exciting White Paper on “A New Era for the Chinese Semiconductor Industry” in American Affairs.
Ownership Breakdown (Simply Wall Street)
Valuation
Three extrinsic reasons give impetus to our valuation as a Hold opportunity. First is the spate of insider buying of shares during the last 18 months. Some insiders paid as much as $7 per share. Just days ago, the CEO, Young-Joon Kim, paid $5.61 per share for 100K shares. He increased his stake by 3.5%. Couple this with the furtive patience of some 24 hedge funds holding onto shares while the price dived from about $10 to a 52-week low of $5.18. We believe the positive activity can indicate a nexus leading to a potential rise in the share price this year.
Magnachip ended Q4 ’23 with no debt and cash of $158.1M. Management uses this treasure to buy back its shares, as YChart’s graph depicts. Rather than pay shareholders a dividend, they undergird the share price. A recently passed buyback authorization of $50M translates to a repurchase of 11M more shares. We do not foresee share buybacks as a smart strategy unless they have another agenda. After all, revenue is falling, gross profit margins are struggling, and net operating income ended FY ’23 at -48.4M.
Buyback of Company Shares (YCharts)
Third, the levered/unlevered Beta for the stock is well below the volatility the stock market experiences. Magnachip’s Beta analysis is 0.08; the 24-month Beta is higher at 0.28 but seems an insignificant difference.
American-China tensions especially over the semiconductor business persist with trade sanctions in force. Magnachip is closely tied to China’s smartphone and auto business. In 2021, there was talk of Magnachip being sold to a Chinese firm but the deal never materialized. The tensions affect other countries’ semiconductor companies, too. China squashed a deal between Intel and an Israel-based manufacturer. The Financial Times claims “Magnachip has no substantive operations…in the U.S.” Nevertheless, U. S. strategic assets purchased from abroad are scrutinized casting a chill, perhaps a pall, over the industry that can directly affect Magnachip’s North American sales.
In March ’24, the share price bottomed at $5.37 each but closed at $5.87 on Mach 15. The catalyst for the 8% pop, in our opinion, is the buying of outstanding shares by insiders, institutions, and the company. Magnachip Semiconductor Corp has been the target of takeovers for years. A Chinese firm was rumored to be offering $1.4B. An investment firm was supposedly competing for $1.66B or ~$35 per share in cash in 2021. And there have been others. The company’s current market cap is $222.3M.
Setting a fair value average target price is inconsequential at this time with negative earnings and questionable revenue growth. The next earnings announcement is set for May 1, 2024. The consensus is the Q1’24 EPS will be -$0.38, dropping deeper than each of the 4 quarters in FY ’23. Thus, the PE is inconsequential. EV/Sales beat the sector median substantially, as does P/S and P/B, the only metrics garnering A grades from S A. Cash flow from operations was a 2023 loss compared to positive income for each of the 5 years prior.
Takeaway
We do not see substantial upsides to the financial and other risks we raise except the possibility the Chinese again have their eye on Magnachip. That can stimulate the surge in insider trading and company buyback of shares. It is cheaper and faster to buy assets than to build them; the CCP cares little about profitability. Growth will come for them from domestic sales to Chinese manufacturers with their sales and exports rebounding.
By its price-to-sales ratio (1x) comparison, Magnachip fairs poorly versus competitors (4.2x industry average) making Magnachip appear as a good value. We are not enthusiastic that revenue will grow, gross margin and net operating income will improve. Without a buyout, the stock can drop into the $3.50 range. To consider a Hold rating of the shares is a gamble, as the share price ticks up. The Sell Quant Rating seems more realistic to us and a safer bet.
