Description

Pixelworks (PXLW) is an overlooked and underappreciated semiconductor company with meaningful upside potential.  The company’s chips help optimize display and video in the projector and mobile markets.  Since inception, the company has amassed 148 patents around its display and video optimization techniques.  Honed in the television market, the company has ported its technology to the low-power mobile market and is the only merchant player there at this point in time.  

While grounded in great technology, Pixelworks is a turnaround story.  The company posted flattish revenue and slightly negative profitability since 2009 and in mid-2016, a new CEO, Todd DeBonis, was appointed.  Prior to joining Pixelworks, Todd was VP of Global Sales & Strategic Development at TriQuint Semiconductor from 2004 to 2015.  TriQuint was a major RF semiconductor company before merging with RFMD to form Qorvo (QRVO).  After reviewing Pixelworks’ business, Todd implemented a 25% headcount reduction and end-of-lifed certain TV and projector parts.  The resulting company is much leaner and more focused.  

The main revenue driver currently for Pixelworks is the projector market.  The company produces high price / high functionality chips for this market and is the only merchant supplier in this market.  The projector market is flattish at 8-9 million units annually.  Half of these units have a lower-end DLP light unit and the other half have a more powerful 3LCD light unit made by Epson or Sony.  The DLP light units are made by Texas Instruments (TXN) and have integrated basic video functionality.  Pixelworks has 80% market share in the 3LCD market and that will be going to 90% as they take more share within Epson this year.  Epson’s confidence and commitment to Pixelworks was demonstrated recently as it agreed to fund development for Pixelworks’ next generation projector video chip.  Growth is the projector market will come from market share gains in the 3LCD market as well as from chipping away at the high end of the DLP market.

The more exciting part of Pixelworks’ business is the mobile opportunity. As mobile displays incorporate more pixels, certain video artifacts arise that harm the viewing experience.  Pixelworks’ video & display enhancement techniques include:

• Halo Free Judder Removal

• Streaming Enhancement

• Scaling & Edge Detail

• Advanced Color Management

• Motion Blur Reduction

• Backlight Management

• Daylight Viewing

• Image Warp & Keystone

Many of Pixelworks’ potential customers reside in China, including Huawei, Oppo, Gionee, Lenovo, Xiaomi, and ZTE.  These customers do not have in-house expertise in video processing.  So far Pixelworks has landed one mobile customer, Asus. Asus is using Pixelworks’ Iris chip in its high-end smartphone and high-end tablet.  Reviews of these products have noted their superior display, color quality and video excellence.

Management has noted that one of the challenges in selling its mobile products is that, unlike in televisions, consumers usually do not do head to head video comparisons in phones that they are considering.  Something has come up recently however, that will likely make Pixelworks’ value proposition clearer to their potential customers.  In February 2017, the Ultra HD Alliance announced a new standard for mobile devices called Mobile HDR Premium.  The Ultra HD Alliance is made up of movie producers and technology companies looking to establish a standard for next-gen entertainment.  This standard is a quantitative measurement of a mobile device’s display capabilities.

The Samsung Galaxy S8, which was revealed recently, is the first phone to earn this badge.  We feel that this will put pressure on other mobile OEMs to also meet this standard and many cannot do so without using Pixelworks’ products.  We expect additional customer wins over the next year that will serve as catalysts for Pixelworks’ stock.

In terms of valuation, we look at the projector business as a stable 50% gross margin business that can now deliver significant profits post-restructuring.  Pixelworks’ market cap is $160 million and the company has $20 million of net cash on its balance sheet resulting in a $140 million enterprise value.  We are forecasting $80 million in 2018 sales so EV / Revenue is 1.5x.  The vast majority of this revenue will be from the projector business as we are being very conservative about the mobile business.  We predict the company will do $14 million in EBITDA in 2018.  At a 12x EBITDA multiple plus the net cash, you get a $6.10 stock price implying 20% upside from current levels.  However, the main upside potential from the mobile business is not captured in this analysis.  If Pixelworks garners two high volume Chinese customers, that could add another $50 million to the top line.  So the way we are thinking about it is that you are buying an undervalued projector chip business with a free call option on an exciting and potentially high growth mobile business.

Catalyst

If Pixelworks garners a majot mobile design win the stock will appreciate rapidly.