Thesis:  I believe Actions Semiconductor (ACTS) is a very undervalued stock, currently trading 16.0% below cash despite improving fundamentals and what I believe to be the bottoming of the Company’s legacy end markets.  I believe the mispricing exists because (1) the Company is a Chinese stock and has suffered from negative sentiment surrounding the surge of Chinese frauds in 2011 and (2) until recently, most of the Company’s end markets were in secular decline. 

Note:  All dollars referenced are in USD unless otherwise noted.  In addition, given the low trading volume of the Company’s shares (less than $180K/day) this idea is probably only suitable for personal accounts and/or small funds. 

Background on the Company:  Actions Semiconductor (ACTS) is a fabless semiconductor that designs, develops, and markets integrated platform solutions consisting of System on Chips (SoCs), firmware, software development tools, and reference designs for manufacturers of portable media players (PMPs) and smart handheld devices such as tablets.  Most of the Company’s sales are made to value-added distributors, but it also sells to contract manufacturers.  Value added distributors integrate the Company’s products into a system platform and sell that system platform to contract manufacturers.  In FY 12, sales to customers in the PRC represented 2.1% of sales and the remainder was attributable to customers in Hong Kong.  The Company’s fiscal year ends on 12/31

I believe there is a low likelihood that the Company is a fraud:  I believe one of the primary reasons why the Company trades at an absurd valuation is because it is a Chinese company.  In 2011, many Chinese companies became under attack from short sellers as frauds—many of them turned out to be in fact frauds.  I believe this negative sentiment has carried over into FY 13 and is a primary reason why the Company trades below cash.  If the Company is in fact a bona fide business (discussed below), the market is not assigning any value to the underlying business.  I believe there is a low likelihood that the Company is a fraud for five primary reasons:

1.       Company became public through a traditional IPO:  Unlike many of the Chinese reverse merger frauds in 2011, ACTS actually went public through a traditional IPO in November of 2005.  While frauds can slip through the crack in the due diligence process of a traditional IPO, I believe the risk of fraud is a lot lower than a reverse merger.

2.       The Company has had the same auditor since it went public:  Since going public in late 2005, the Company has had the same auditor, Deloitte Hong Kong.  Given that the Company has utilized the same auditor since going public in 2005, my concerns about potential fraud are somewhat lower.

3.       Impact of related party transactions have diminished in recent periods:  Based on my experience, many fraudulent companies have engaged in various related party transactions to boost revenue or margins—in other words, many of these transactions were not arms-length transactions and simply served to inflate revenue.  In FY 12, FY 11, and FY 10, the Company generated $1.8 million (3.3% of revenue), $5.8 million (12.2% of revenue), and $7.5 million from GMI Technology (19.9% of revenue).  The president of GMI Technology is the older brother of Mr. Yeh, Nan-Horng, one of the Company’s directors (and former CEO).  Since FY 09 related party revenue has declined as a percentage of total revenue, bottoming to 3.4% in FY 12.  Further, in FY 12 related party gross margin declined to the lowest level in four years.  Given that related party revenue and gross margin have been declining for several years, I do not believe the Company has utilized the relationship to inflate revenue in recent periods. 

 4.       Executive ownership is relatively small:  As of 04/22/13, the directors and executives held options to purchase 390,000 ADSs (representing 2,340,000 ordinary shares) and 100,000 restricted stock units (representing 600,000 ordinary shares).  Based on the above numbers, I estimate the directors and executives beneficially own 2,940,000 ordinary shares, representing 0.72% of shares outstanding.  While a small insider ownership is normally not interpreted as a positive thing, in this case I think that it takes out the incentive for management to engage in fraud.

5.       Management cut compensation in the recession:  In the midst of significant business turmoil in FY 09, the Company’s executives voluntarily reduced their compensation first before subsequently cutting salaries at the VP and department head level.  In my view, it is admirable that the Company’s executives would take cuts first to help out margins.  Further, I believe this supports my prior thesis that the executives do not seem financially incentivized to engage in fraud. 

“Facing a tough business environment, we have taken additional measures to further reduce our operating expenditures.  Since the beginning of the year, we have implemented an average 100% compensation reduction for our senior management teams and for most of our VP and Department Head, as well as even stated a hiring freeze on all non-R&D functions where we are currently reviewing our head count. As part of our stage two plan, our cash flow reduction, we will continue to monitor business conditions and are actively considering further cost saving procedures focusing on lowering overhead.”—Q2 09 Conference Call

Background on cash and cash equivalents:  The Company’s cash and cash equivalents consist of (1) cash and cash equivalents, (2) time deposits, (3) current and non-current marketable securities, and (4) trading securities.  Cash and cash equivalents consist of cash on hand, demand deposits, and highly liquid interest earning deposits with maturities of three months or less.  Time deposits consist of deposits in financial institutions with original maturity terms of greater than three months, but less than one year.  Marketable securities are investments purchased by the Company from banks or independent financial institutions in the PRC.  The investments include money market deposits and trust financial products with market based interest rates with maturities ranging from 3 – 24 months.  Trading securities consist of investments in publically traded mutual funds in Taiwan. 

Uses of cash—only on stock repurchases, no tender offers or dividends on the horizon:  Based on Conference Call commentary, I believe the Company’s large cash balance has been a source of frustration with many investors in recent years.  In fact, one of the Company’s long-term stockholders, Rick Fearon from Accretive Capital Partners, has repeatedly suggested the Company utilize its cash balance to conduct a tender offer.  While the Company has acknowledged Mr. Fearon’s urging on pretty much every single Conference Call in the past 4+ years, it has not even given the slightest hint of its intention do so. 

Based on my interpretation of Conference Call commentary in the past few years, I believe the Company wants to purchase its shares back at the lowest price possible (i.e. instead of paying a “premium” in a tender offer).  Further, I believe the Company may be afraid that the tender offer will only result in a temporary increase in the Company’s stock price.  Taking these factors into consideration, I think the possibility of a tender offer as a near term catalyst is very slim.

“We have already tried very hard to buyback our shares. However, in terms of the tender offer, we are not so sure about the effectiveness and the efficiency of this approach because the goal for our repurchase program is for increasing the long-term shareholder value. If we go by the tender offer method, it may or may not protect the value of our long-term shareholders.  So, we would like to try the open market method first.”—Q3 08 Conference Call

Further, based on commentary from the FY 20-F, I believe the likelihood of the Company paying a dividend is also extremely unlikely.  In its FY 20-F the Company represented it currently intends to retain all earnings to finance the expansion of its business.  Accordingly, the Company does not intend on declaring or pay any dividends in the near-to-medium term.  I think this is something the bulls tend to point at for a possible catalyst, but I just don’t think its something that is likely to occur within the next few years. 

“We currently intend to retain all of our earnings to finance the development and expansion of our business and therefore do not intend to declare or pay cash dividends on our shares and ADSs in the near to medium term.”—FY 12 20-F

While the Company may not be declaring dividends or conducting tender offers, it has been buying back shares.  For the last few years, the Company has accounted for ~10.0%+ of the daily trading volume (on average) of its shares.  Since the commencement of the buyback program in 2007, the Company has spent $47.1 million repurchasing 20.9 million ADSs.  On its Conference Calls for the past 5+ years, the Company has repeatedly represented that its ability to repurchase shares en masse is limited by the low trading volume of its ADSs and blackout periods.

In the end, I believe that the near-term catalyst that some bulls are looking for in the form of a dividend and/or tender offer is simply unrealistic.  However, I still believe that the Company’s large purchasing activity should provide support for the stock price.

Historical analysis of the Company’s fundamental decline since 2009:  Since the global recession in 2008/2009, the Company’s PMP/MP3 end markets have been in secular decline.  In 2006, the Company’s revenue peaked at an all time high of $170.2 million (with a gross margin of 55.4%).  According to research published by IDC in April 2009, IDC believed the worldwide semiconductor market for PMPs would drop significantly from $7.5 billion in FY 08 to $4.6 billion in FY 13.  When the recession hit in 2008/2009, demand for consumer electronics dropped significantly.  The Company also faced increasing competition in the PMP semiconductor space.  As a result of (1) significantly lower demand due to the global recession, (2) a large excess supply of industry inventory, and (3) a shift in consumer electronic devices toward multi-function devices (discussed below), the Company’s revenue and margin quickly deteriorated.  In response to lower demand, the Company aggressively lowered price to maintain market share—the result was disastrous.

“Yes, you pretty much pointed out the major reasons of the price erosion in the fourth quarter.  Number 1, along with the global macroeconomic slowdown all of the consumer electronics are under a super price pressure and the shrinkage of the demand and to keep our market share in the PMP market we have to react to the extraordinary price pressure especially in the ultra low-end”—Q3 08 Conference Call

As a result of the global recession in 2008/2009 in conjunction with significant new competition (in the form of mobile devices and multi-function devices) and a large excess supply of industry inventory at a time of lower end market demand, revenue and margins deteriorated quickly.  Beginning in 2008, ASP and volume were pretty much in free fall, declining by double digits for three years straight before bottoming out in FY 10.  The result of the Company’s strategy to maintain market share was a total collapse of revenue and margins.  In FY 10, the Company generated just 39.0% in gross margin on $37.6 million of revenue, a mere shadow of the Company’s heyday a few years earlier. 

I believe following data points suggest a flat and/or continued decline (albeit a smaller decline) in the PMP end markets:

• According to research conducted by IHS in July 2011, as a result of rising sales of multi-function electronic devices such as smart phones and tablets, there has been a long-term secular decline in single-task consumer electronic devices (i.e. the Company’s legacy end markets).  The research estimated that shipments of smart phones and tablets will continue to grow at double digit rates through FY 15, while shipments of PMP/MP3 players will either decline or remain flat over the same period

• According to research conducted by Gartner in November of 2012 the PMP market continues to decline as competition from low-cost smart phones and tablets increase.  Further, the research indicated the only area expected to grow in connected devices are those that run leading mobile operating systems including Android and iOS. 

While the Market of PMPs (particularly MP3s) has continued to decline through FY 13, I believe the revenue decline may have bottomed out for the Company.  Further, given the Company’s recent entrance into the tablet market (discussed next), I believe it may return to strong top-line growth and profitability—assuming it can maintain current tablet momentum. 

Background on the white box tablet market:  The worldwide tablet market can be broken down into three segments (1) Apple tablets, (2) non-Apple tablets, and (3) white box tablets.  In 2012, the tablet market entered a period of rapid growth, particularly in the low-end low-cost tablet market—AKA the “white box” tablet market.  White box tablets are local or non-branded tablets that are very low priced (i.e. sub $100 USD).  The price points of many branded tablets such as Apple’s iPad and Samsung’s Galaxy series are not priced at attractive and/or affordable price points in emerging countries.  According to research conducted by , in FY 12

Based on the Company’s June 2013 Investor Presentation, it estimates that from FY 11 to FY 13, the shipment of Apple tablets will increase from 41.0 million units to 80.0 million units and the shipment of non-Apple tablets will increase from 22.3 million to 80.0 million.  Further, the Company estimates that over the same time frame, the shipment of white box tablets will increase from 10.0 million units to 100.0 million units. 

I believe the following data points supports the Company’s claims of an increasing white box tablet market:

• According to a recent report by NPD DisplayResearch in May 2013, NPD estimated that white box tablet PCs accounted for one-third of tablet PC shipments in FY 12 and will remain at that level for the next several years.  Further, NPD estimated that tablet PC shipments will increase 67.0% year-over-year to 256.5 million in FY 13, implying a white box tablet market of 85.5 million units. 
  “The mobile PC industry is undergoing significant change this year.  The rapid rise and establishment of white box tablet PCs (tablets made by small local brands, mainly in China) is putting pressure on traditional notebook PCs. These low-cost tablets are reaching further into emerging regions where notebook PC penetration rates have remained low, resulting in cannibalization by tablet PCs.”—Richard Shim Senior Analyst at NPD DisplayResearch

• On 07/02/13, IHS announced that it had increased its forecast for tablet panels by 6.0% for FY 13 due to an increase in orders from white box Chinese manufacturers.  Accordingly, ISH now estimates shipment of 262.0 million tablet displays in FY 13.

The Company may benefit from growth in the white box tablet market:  In March of 2012, the Company launched its first tablet product, the ATM 7013, followed by the launch of the ATM7029 in December 2012.  In Q1 13, the Company began shipping the next generation of its tablet SoCs, the OWL Series.  Early results of the OWL series were positive.  In Q1 13, revenue from tablets represented 39.0% of total revenue, up significantly from 13.0% in Q4 12—implying growth of $4.4 million or 224.9% sequentially.  The Company expects to begin shipping new products in the OWL series in Q2 13.  Further, the Company expressed its intent to follow up with additional tablet product introductions throughout the year.  On its Q1 13 Conference Call, the Company believed it currently had a mid single digit market share in the white box tablet market.  On the Call, the Company expressed its intention to increase that market share to 10.0% by the end of FY 13.  I believe that if the Company is able to maintain current momentum in the white box tablet market, it may be able to return to strong revenue growth and profitability. 

Conclusion:  I believe the ACTS trades at an absurd discount (i.e. below cash) in part due to the fact that it is a Chinese company.  Further, I believe that the Company’s legacy business has bottomed out and it may experience a return to strong revenue growth and profitability if it can establish a strong position in the white box tablet market. 

Risks:

1.       While I believe my research suggests there is a low likelihood the Company is a fraud, there may still be a chance that it is a fraud.  Further, there may also be a chance that the Company may have inflated its cash balance to attract investors—if that were the case, I think a serious revaluation of your margin of safety is warranted. 

 2.       If the Company switches auditors or receives anything less than an unqualified opinion, I think it would be wise to sell the stock.

 3.       If there a significant deterioration in the legacy PMP/MP3 business that offsets growth in white box tablets. 

 4.       Most importantly, if the Company is not able to establish and/or maintain a strong position in the white box tablet market. 

Catalysts:

1.       Continued strong stock repurchases should help support and/or increase the stock price.

2.       Negative sentiment surrounding Chinese stocks to pass will hopefully result in the Company to trade above cash.

3.       Most importantly, continued strong momentum in white box tablets