Description

Power Integrations, Inc. (“Power Integrations”, “POWI”, or the Company”) is manufacturer of analog/mixed-signal integrated circuits used in power conversion applications. POWI’s products are used mainly for the conversion of high voltage AC to low voltage DC power required by most electronic devices. POWI’s products are used in a variety of appliances, cell phones, computers and a wide variety of markets. For the LTM period, Power Integrations generated $395MM of revenue and $84.4MM of Adj. EBITDA. 

Current Set-Up

Semiconductor euphoria is at all-time highs as evidenced by the SOX index up over ~25% YTD despite a plethora of negative news and poor earnings. Driving much of the recent price action is “FOMO” on the fundamental improvement of semiconductor end markets and the recovery in earnings as many market participants believe they have missed on what they perceive to be the trading price bottoms recently witnessed in 4Q18. 

Our variant view is that fundamentals and earnings for certain semiconductor businesses are not recovering in the near-term despite valuations more than pricing in a fundamental recovery, leaving little room for error. Channel data such as semi DIOs, peak channel inventories driven by double order, EMS/disti and customer commentary tend to suggest little to no improvement and in some cases further deterioration. 

We have opted for a basket of semiconductor and semi-cap companies for which expectations and perceived quality vis-à-vis valuation are too high. Power Integrations is one example of a constituent of our basket. POWI is a fine business yet trades at all-time high multiples on almost every metric for a business facing increasing competition within its historic end markets. The opportunity exists due to the following:

Bull Point #1: Excitement over USB-PD Charging Opportunity

Over the years, POWI has been a relatively boring MSD top-line grower. Share price appreciation over the past two quarters has been driven by excitement over the potential opportunity for converter chips within USB-PD wall chargers. Revenues in this segment have been driven largely by Chinese OEMs who have likely pulled forward sales.  

This is a relatively low margin segment (high 30% to low 40% GMs) with a relatively high amount of competition. Within the “box”, others such as Dialog have strong market share. Moreover, it’s not a surprise to learn that Chinese OEMs are aggressively moving away from US semiconductor manufacturers in favor of domestic and “friendly” silicon. To summarize, selling into Chinese OEM cellphone manufacturers is not a great business as we believe this is a temporary, low margin “hyped” opportunity that won’t save the company over the next year or so. 

Bull Point #2: Revenue Beat & Good Guide

POWI top-line results came in at the high end of their guide and ~2% above the street. 3Q guide for topline also came above at ~$114MM versus $112MM expected. We think there is a good chance POWI will disappoint, particularly on 4Q results as its evident recent revenue beat was driven more so by accounting games than broad based outperformance. 

• For reference, net A/R increased 240% YoY, while gross DSO days increased 22%, implying some channel stuffing or aggressive terms on declining revenues.

• Power Integrations utilizes an allowance for ship, debits and stock rebates as a contra A/R account. Notably for the past quarter POWI took down these allowances to ~9% of revenues and drew down the reserve at a faster rate than the current revenue declines. We’ve generally seen this type of activity amongst a few other semiconductor peers (MXL) as a quick method in order to artificially maintain revenues in the short term. 

• Inventories are up ~30% YoY on revenues down 6% with DIOs up a staggering 37% YoY. We will likely see intensified pricing pressure/margin compression as POWI will either have to slow down on utilization or take heightened discounting. 

• POWI has some of the lowest visibility vis-à-vis peers and has massively whiffed in the past (called out double digit growth at the end of 2017 for the foreseeable future)

Insider Selling & Other Misc Items

• Management have been aggressive sellers of stock over the YTD period, with certain individuals such as the CFO selling material portions of their stakes. 

• POWI has ceased its buyback this Q. Conversations suggest that this is driven by the current all-time high valuation. 

Valuation

• Power Integrations trades at all-time high multiples on an absolute basis and when compared to its historic range, currently at ~6x LTM/5x fwrd revenues vis-à-vis the average at ~3x to 4x. On an earnings basis, POWI also trades at an egregious valuation at over 30x fwrd EPS and a sub 2% FCF yield. Note these are generally multiples ascribed to fast growing semi businesses. 

• Generally niche semiconductor assets with LSD to MSD growth and gross margins in the 50% range generally sell for ~3x revenues in the private markets, while certain transactions have been consummated at or slightly than ~4x if end market demand is strong. This corresponds with what we have gathered on what competitors would likely pay for POWI if the opportunity ever arose. 

• As hope for a sharp Q4/1H20 rebound becomes less likely over the coming months, POWI should re-rate to ~3x to 4x rev or ~$50 to $60 per share. Moreover, even if street estimates materialize, POWI would be expensive at ~28x fwrd EPS.

Catalysts

We believe Power Integrations equity will re-rate over the next 6 to 12 months due to: 

(1) end markets served by POWI continuing to weaken such as Chinese appliances or continue to bounce around the bottom; 

(2) USB-PD and generic rapid charging cellphone wall-chargers disappoint due to a combination of lower margins, competition and stifled impact as cellphone wall-chargers are only ~20% - 25% of revenues versus past cycles where the mix was materially higher. 

Collectively these items should hinder the Q4 guide vis-à-vis street expectations and make the FY20E ramp of ~14% growth YoY unachievable. Secondly, if we are wrong and the end markets do turn and/or USB-PD is a materially larger and a more sustainable driver of earnings than what historically has occurred in the past, valuation support is no longer apparent at ~$85 per share given the valuation vis-à-vis historic avgs

Disclaimer

The author of this posting and related persons or entities ("Author") currently holds a long position in this security.  Author may purchase additional shares, or sell some or all of Author's shares, at any time.  Author has no obligation to inform anyone of any changes to Author's view of POWI.  Please consult your financial, legal, and/or tax advisors before making any investment decisions.  While the Author has tried to present facts it believes are accurate, the Author makes no representation as to the accuracy or completeness of any information contained in this note.  The reader agrees not to invest based on this note, and to perform his or her own due diligence and research before taking a position in IOTS.  READER AGREES TO HOLD AUTHOR HARMLESS AND HEREBY WAIVES ANY CAUSES OF ACTION AGAINST AUTHOR RELATED TO THE NOTE ABOVE.  As with all investments, caveat emptor.

Catalyst

(1) end markets served by POWI continuing to weaken such as Chinese appliances or continue to bounce around the bottom; 

(2) USB-PD and generic rapid charging cellphone wall-chargers disappoint due to a combination of lower margins, competition and stifled impact as cellphone wall-chargers are only ~20% - 25% of revenues versus past cycles where the mix was materially higher.