Description

Thesis:  ACTS seems to be the lowest valued stock in the world, valued at an 81% discount to net cash and equivalents and at a price/book value of 0.42x, without a meaningful cash burn, and profitability likely this year. ACTS stock price is $1.67 (market cap $115 mil), with approximately $3.03 ($208 mil) of net cash and equivalents. Thus, giving no value to their semiconductor business (with $44 mil in FY11 revenues) and other assets, the stock could rise 81%, with a fair value that I think is significantly higher. My analysis indicates in most reasonable scenarios the stock has one year upside/downside potential of 200%/(10%), with a significantly higher probability of moving up. There are numerous catalysts that I expect could drive the stock to fair value, including a potential Dutch auction, LBO, accelerated share repurchase, more shareholder awareness as management increases marketing meetings, and significantly increasing revenues and earnings as the company rolls out its new products and gains additional market share in its existing products.

The Company:  Actions Semiconductor is a China based fables semiconductor company, whose shares trade on the Nasdaq. The company designs, develops and markets integrated chip (SOC) solutions for a variety of end markets, including MP3, MP4, portable multimedia devices, automotive, boom box, and Android devices. Actions has leading market share (excluding Apple products) in many of its segments including, 70%+ in color display and high-end automotive audio/Boom Box,  70% share in QVGA/D1 PMP segments, and 45%+ market share from QVGA, MP4/D1, PMP/HD, and PMP. Actions has approximately 500 engineers, and 106 patents, with an additional 120 patents pending.  The company develops high quality and low cost products by leveraging its intellectual capital and the low cost manufacturing infra-structure within China.

History: ACTS went public in an offering led by Morgan Stanley in 2005, when at the time the company’s revenues and earnings were growing tremendously (to $116 mil in FY2007) due to its SOC semiconductor products for the MP3 and other markets, driving the stock price as high as $12. Within a couple of years following the IPO, ACTS’ management lost focus, slowed introduction of new products, and eventually left the company. This series of events coupled with price erosion in the company’s legacy markets caused a significant reduction in the company’s revenues ($37 mil in FY2010) and profitability, resulting in a meaningful reduction in the stock price. Over the last two years the company has rebuilt its management team, introduced a series of new products and/or acquired new capabilities, has begun to grow revenues again (up 27% in FY2011 to $47 mil), and is now poised for near-term profitability.

Balance Sheet:  ACTS most attractive investment characteristic is its rock solid balance sheet. As of 3/31/2012 the company had $33.8 mil of cash equivalents, and $187 mil of marketable securities (which I also refer to as cash equivalents in this report), for a total of $221 mil, or $3.15 per share. The company also has an additional $32 mil in investments in joint ventures and $33 mil in property plant and equipment. The only meaningful liability the company has is a $12 mil short-term bank loan they use to keep a credit line opened. ACTS has total shareholders equity of about $270 mil and is valued at a price/book value of only 0.42x. The company’s management and board are highly conservative and have virtually all of their $187 mil in marketable securities in what has been characterized as very low risk/volatility investments with relatively low returns. Most of the marketable securities consist of investments which were issued, managed or guaranteed by state-owned banks or financial institutions in China. Most of these investments have guaranteed interest rates with terms of 3 to 24 months.   

Cash Flow: On an operating basis ACTS is currently about cash-flow neutral, neither generating or burning a material amount of cash. The company has been using a portion of its cash to buy back as many shares as they could in the open market, which has been challenging for the company given the stocks limited liquidity. Over the last four years the company has bought back approximately $42.5 million of its own shares and continues to have a very active repurchase program. ACTS has also invested some minimal-to-moderate amounts of cash in new facilities, joint ventures and acquisitions. The company has stated that they are very cautious with using their capital.

Income Statement:  Over the last few quarters ACTS has been basically break-even from a net income perspective. However, the company’s revenues have hit the growth inflection and were up 27% in FY11, and management expects them to be up another 15-20% in FY12. The primary reason why the company has not yet been profitable with the recent revenue growth is because they have been investing a significant amount of money in research and development (R&D) to secure the company’s future growth. ACTS spent $22 mil in R&D in 2011 (46% of the company’s revenues) versus a $12 mil R&D spend in 2007 (10% of revenues). ACTS could be profitable anytime they choose by scaling back operating expenses but they have made the choice to invest for their future, which I think makes sense and is finally starting to pay off from a revenue perspective. The company has a number of high-end, higher margin products coming to market this year and next which should drive revenue grow, and push the company into sustained profitability.

Valuation: I believe the current fair value of the stock is anywhere between $3.80-$5 (up 126-200%) with longer-term upside potential which could be significantly higher. I derive the fair value by giving the company an EV/Revenue multiple of anywhere from 1-3x which is where comparables are currently valued. It would be difficult for anyone to argue that at minimum the company should currently be valued at below net cash and equivalents of $3.03 (up 81%). Also, the company has about $3.91 of current book value and I think it could be viewed as fair for the company to currently trade at 1x book (or $3.91 - up 135%) until they prove themselves over the next couple of quarters.  

Risks: There are a variety of risks for a small-cap Chinese fables semiconductor company such as ACTS that include the business cycle, the strength of the company’s specific products, manufacturing disruptions, competition, liquidity of the shares and potential geopolitical risks among others.  

However, given the company’s vast discount to cash and equivalents, I think the primary meaningful potential risk for ACTS stock going down below the current price for a sustained period of time would be if there was some kind of fraud going on at the company, which I unequivocally believe in not the case. To note, there has been absolutely no red flags or indications that the company has ever did anything improper. ACTS has used the same big 4 accounting firm (Deloitte Touche) since going public, who has expressed only unqualified opinions on the company’s books and records. I have personally set up several calls throughout ACTS supply chain and spoken with current and prior employees, suppliers and customers, and have not turned up anything suspicious. ACTS public offering was also lead by a top Wall Street firm that did their own due diligence. Finally, if ACTS were cooking the books there results probably would have been a lot better than what we have seen over the last few years, with breakeven EPS and revenues declining tremendously (until recently).

Catalyst

Catalysts:

1)      A potential significant return of capital to shareholders: ACTS has a history of repurchasing shares, and this program remains active at this point. However, the company’s buyback has been constrained by the limited liquidity of the stock. Over the last few years shareholders have been pushing hard for some sort of larger Dutch auction or large one time dividend. Until recently the company did not seem willing to move in this direction. However, on the company’s last call they indicated strongly for the first time that they were actively evaluating ways to expand the share repurchase and return more capital to shareholders. I think this change in the company’s tone comes from the fact that their business is turning around positively, and there are new voices in the management team. ACTS has enough cash and equivalents to buy back the entire shares outstanding with plenty to spare for operating the company.

2)      A potential LBO or acquisition: Given the high cash balance of the company and comparable valuations it would make a lot of sense for the company to go private, or for an outsider to acquire the company and bring it public again at a later time. The company or an outsider could simply use the cash and equivalents to buy the company for $3+ and get the entire operating company for free. Another company could also acquire ACTS given the valuation.

3)      Dramatic turn in the company’s operations: ACTS seems to be at a fundamental inflection point after several years of effort which should create a stream of positive news and catalysts as revenues continue to grow and the company potentially achieves sustained profitability.

4)      More active promotion from management: ACTS management has indicated that they plan to be more active in promoting the company to investors through attending various marketing meetings and conferences which should improve investor awareness of the stock. Over the last few years the company has done little or no marketing as management was focused on turning around the company.