Monolithic Power: AI And 5G Are Growth Drivers (NASDAQ:MPWR)

Monolithic Power Systems, Inc. (NASDAQ:MPWR) recently delivered better than expected EPS, and reports exposure to relevant FCF drivers from the growing AI industry, 5G, or the Internet of Things. The company also reports significant R&D expenditure for exploration about systems architecture, circuit design, and implementation in addition to process technologies. Besides, there is an ongoing stock repurchase program, which may also accelerate the demand for the stock. There are several risks; however, I think that Monolithic Power Systems could trade at better price marks.

Monolithic Power Systems

Monolithic Power Systems, Inc. has international reach, and offers solutions for the electronic sector through semiconductors. The company does not have its own manufacturing capabilities, so it outsources the production of its own designs, and then manages their distribution.

Clients come from diverse fields, although the greatest concentration is among those in the computing and storage markets as well as the automotive sector, which accounted for around 50% of the company’s revenue in 2023. There are also clients of the areas of internal organization as well as electronic devices and communication networks.

For Monolithic Power Systems, the distribution is provided by third-party agents, in some cases directly to the original manufacturers, although the company has offices in a large number of countries in Asia, where global semiconductor manufacturing is concentrated, in addition to the United States and Europe. In any case, the company’s current manufacturers are located in China, Taiwan, and South Korea, from where the distribution of its products takes place.

The company operates a single business segment, which is operated with a light asset structure, without having its own manufacturing or distribution capabilities. Monolithic develops and patents the design of semiconductors, and in some cases these developments occur precisely with the research bodies of its clients, achieving customized products that are part of the value chain of the final products.

On the other hand, the company maintains its proprietary designs oriented toward easy integration into third-party designs. The company’s main product line is DC to DC converters, widely used in the aforementioned markets, computing and automotive, specifically in the manufacturing of electronic cars.

These products offer voltage solutions, and represented 96% of the company’s sales in 2023. On the other hand, representing the remaining percentage, Monolithic also offers solutions and lighting, generally applied to electronic devices, cell phones, computers, and cars through low-cost LED designs.

Monolithic Power Systems reported better than expected EPS and quarterly revenue in the last quarterly report. Besides, according to Seeking Alpha, more analysts increased their quarterly EPS expectations for the next quarter. Finally, consensus EPS expectations for Q2, Q3, and Q4 in 2024 are better than what the company reported in 2023. Given these figures, I would expect that a lot of new investors may want to have a look at the company’s financial figures.

Balance Sheet: No Debt, And A Substantial Amount Of Cash In Hand

As of March 31, 2024, the company reported $488 million in cash, with short-term investments worth $798 million and total assets of $1.9 billion. With these figures, including the short-term investments, I obtained net debt close to -$1.2 billion.

The current assets/current liability ratio stands at close to 6x, and the asset/liability ratio stands at more than 5x. The company does not report debt; hence, I believe that liquidity does not seem a problem.

FCF Driver 1: Monolithic Power Systems Could Receive Significant Traction From The AI Revolution

Monolithic Power Systems noted in the last presentation to investors that there are many growth drivers that may accelerate net sales growth. Among the growth drivers noted there is the growth from AI developments in the computing industry. Besides, the company noted that 5G and the Internet of Things could also accelerate revenue growth.

I reviewed the target markets in which Monolithic Power Systems is present. Enterprise Data as well as Storage and Computing are the largest markets.

According to market experts, the global cloud data center market size could grow at close to 10% from 2024 to 2033. Besides, the Enterprise AI market could grow at close to 31% from 2020 to 2027. I included these figures in my DCF models. Under my best case scenario, the median net income growth could stand at close to 12%.

The global cloud data center market size was estimated at USD 26.66 billion in 2023 and is predicted to hit around USD 69.45 billion by 2033 with a CAGR of 10.05% from 2024 to 2033. Source: Precedenceresearch

The Compound Annual Growth Rate of the Enterprise AI market is expected to be 31.3% during the 2020-2027 forecast period. The Compound Annual Growth Rate of 31.3% for the Enterprise AI market from 2020 to 2027 indicates the average annual growth rate over this forecast period. Source: Gitnux

FCF Driver 2: The Development Of New Products And New Acquisitions Could Bring Significant Net FCF Growth

Monolithic Power Systems will most likely grow organically thanks to its ability to develop new products as well as scaling the sales of its products based on the growth of the end markets it serves. The company is making a significant amount of efforts by conducting research around systems architecture, circuit design, implementation, and process technologies.

In the last annual report, management provided a lot of details about the recent exploration of new applications. I believe that the following lines are worth having a look at.

Our research and development efforts are generally targeted at three areas: systems architecture, circuit design and implementation, and process technologies. In the area of systems architecture, we are exploring new ways of solving our customers’ system design challenges and are investing in the development of systems expertise in new markets and applications that align well with our core capabilities. In the area of circuit design and implementation, our initiatives include expanding our portfolio of products and adding new features to our products. In the area of process technologies, we are investing in research and development resources to provide leading-edge analog power processes for our next generation of ICs. Source: 10-k

Along with this, the strategy of acquiring similar businesses remains active, and during February 2024, the company acquired Axign B.V., a digital signal processing company. Considering the current amount of cash in hand and the state of the balance sheet, I believe that we may see new acquisitions in the coming years. As a result, I believe that we could reach higher net sales growth than that in the past.

On January 3, 2024, we acquired Axign, a Dutch company for $33.8 million in cash. As part of our business strategy, from time to time we review acquisition prospects that would complement our current product offerings, enhance our design capability or offer other competitive opportunities. Source: 10-k

FCF Driver 3: Moving Manufacturing Facilities Outside China Could Be An Option

Regarding the long-term strategy, I believe that the company could move part of its manufacturing affiliates to the territory outside of China and the Asian territory. In my view, at this point, it is important to consider that geopolitical tensions between China and Taiwan, in recent years, have grown, and any escalation in this conflict could bring a critical situation for the sector in general since, as I mentioned previously, a large part of the global semiconductor manufacturing is concentrated in this region. Finally, I believe that finding new locations could also bring an enhancement of the FCF margin growth as well as manufacturing capacity increases. The company discussed in the last annual report that new customers from regions outside Asia may bring net sales growth.

Our ability to achieve revenue growth will depend in part upon our ability to continue to innovate while fulfilling our customers’ evolving needs, enter new market segments, obtain design wins, grow our sales to customers in regions outside China, Taiwan and other Asian markets, expand our customer base and continue to secure manufacturing capacity. Source: 10-k

We Could See Lower WACC Thanks To The Stock Repurchase Program

Monolithic Power Systems approved a stock repurchase program, which may accelerate the demand for the stock and lower the cost of capital. There is an authorization to repurchase shares worth up to $640 million, which I do not consider to be a small amount.

In October 2023, our Board of Directors approved a stock repurchase program authorizing the repurchase of up to $640 million in the aggregate of our common stock. The repurchase program will expire on October 29, 2026. The amount, timing and execution of our stock repurchase program may fluctuate based on market conditions and our priorities for the use of our cash. Source: 10-k

With Successful FCF Drivers, My DCF Model Implied A Valuation Of $804 Per Share

Under this scenario, I included the following assumptions. 2034 net income would be close to $1.791 billion, with net income growth of close to 11.89% and median net income growth of 12.37% from 2024 to 2034. I took into account previous cash flow statements to come out with my figures. I believe that my figures are conservative.

I also assumed that 2034 depreciation and amortization would be about $157 million, with amortization of premium on available-for-sale securities of approximately -$22 million and deferred taxes of close to $8 million.

In addition, I included 2034 stock-based compensation expenses of $619 million, with changes in accounts receivables of close to $103 million, changes in inventories of $399 million, and changes in other assets of around -$1365 million.

I also forecasted accounts payable of close to $28 million, approximately -$8 millions in accrued compensation and related benefits, and income tax liabilities close to -$25 millions. In addition, with changes in other accrued liabilities of $19 million, I obtained 2034 CFO of $1705 million, and after discounting the capex of at least $159 million, 2034 FCF would be close to $1545 million.

If we consider a WACC of 8.9%, the NPV of future FCF would be close to $6553 million. Furthermore, I estimated a terminal value close to $79.282 billion, with an EV/FCF of 51.3x. I also estimated NPV of the terminal value of $31.383 billion, resulting in an enterprise value of $37.936 billion.

By subtracting the total net debt of -$1.286 billion, we would obtain an equity value close to $39.223 billion. With shares outstanding of close to 48 million, the fair price would be close to $804 per share.

Competitors

Competition in this market is high, and comes from both international and regional manufacturers, among which in many cases are companies that have greater production and distribution capabilities than Monolithic. Furthermore, it is expected that competition in these markets will continue to increase due to the emergence of new participants and the growth of the industries they serve. Some of the main competitors for this company are Analog Devices (ADI), Infineon Technologies (OTCQX:IFNNY), NXP Semiconductors (NXPI), ON Semiconductor (ON), Power Integrations (POWI), or Renesas Electronics (OTCPK:RNECF). Among these, there are companies that have models similar to those of Monolithic and those that have their own production capacities.

Risks

As previously pointed out, one of the main risks of this company is that the manufacturing and sale of its products are concentrated in Asian territory, and any critical situation for the economy of this region, or similar situations in Hong Kong could bring complications regarding production and distribution logistics.

Within this factor, we must also take into account the regulatory situations proposed by the Chinese government and the legal uncertainty in this sense, since any radical change could mean an increase in tariffs, difficulties for the import and export of products, and the transfer of capital or corporate procedures.

In more general terms, any situation affecting the demand for semiconductors at a global level as well as a reduction in activity in the markets that the company serves would bring complications at an operational level. In addition, if the demand for the products is increased, the company would not be in a position to cover it with its current production capacities.

My Worst Case Scenario Included Failed FCF Drivers

Under this case scenario, I assumed that Monolithic would face a challenging period. 2034 Net income would be close to $1264 million, with a net income margin of 6.64%, slightly below the historical median net income growth of 8.40%.

In addition, with 2034 depreciation and amortization of close to $572 million, I included amortization of premium on available-for-sale securities of approximately -$55 millions. Besides, with a loss on deferred compensation plan investments of about -$40 million, I also assumed changes in deferred taxes of close to $40 million.

I also expected an increase in the stock-based compensation expense, which could reach $2,259 million in 2034. Additionally, 2034 changes in accounts receivable are estimated at close to $181 million, with changes in other assets close to -$3,264 million.

I also foresee changes in accounts payable to be close to $82 million, with the accrued compensation and related benefits of at least -$76 million and changes in income tax liabilities of close to -$33 million. Besides, with changes in other accrued liabilities of about $156 millions, 2034 CFO would be around $2,042 million. After discounting the capex of at least $582 million, I calculated a 2034 FCF of at least $1.459 billion.

If we take into consideration a WACC of 9.5%, NPV of future FCF would stand at $6.170 million. Additionally, the terminal value would be close to $67.139 million, with an EV/FCF ratio of 46x.

With these figures, the enterprise value would be close to $30.911 billion. By subtracting the total net debt of -$1.286 million, we can obtain the equity close to $32.198 million. Finally, with an estimate of 48 million shares, I obtained a fair price of $660 per share.

Conclusion

Monolithic Power Systems delivered better than expected EPS in the last quarter. The company could soon receive net sales traction from the growing AI revolution, IOT, or the cloud-based data center market. Besides, I believe that further R&D expenses in systems architecture, circuit design, and implementation as well as process technologies could also bring product development, which may accelerate net sales growth. There are obvious risks from failed introduction of new products, geopolitical tension between Taiwan and China, or supply chain disruptions. With that, I think that the company trades undervalued.