Description

Silicom is a truly undiscovered company with terrific growth potential trading at a value multiple.  After a few years of sideways revenue, the top line is poised to ignite on the back of three growth vectors.  If I am correct, 25% revenue growth for the foreseeable future is not out of the question.  There is plenty of operating leverage in the model so revenue growth will translate to rapid margin expansion.  Silicom entered the doghouse a few years ago after losing a large contract with IBM due to IBM getting cold feel on the innovative new switching approach the companies were taking together.  The company has now been virtually forgotten just as the inflection point of new revenue growth is approaching.

Silicom designs network interface cards (NICs), universal customer premise equipment (uCPE), and distributed units (DU) for use in a variety of applications.  NICs are cards that incorporate a chipset that go into empty slots in a network appliance.  NICs were Silicom’s original product line and are used to provide network connectivity and CPU offload in devices such as firewalls, storage devices, WAN optimization boxes, and many others.  Silicom is the NIC leader both in terms of market share as well as product breadth, with no competitors even close to its market position.  Silicom has over 300 cards in its product line compared to its closest competitor with only 40 cards.  Silicom is also known for its excellent customer service which makes its customer relationships very sticky and allows it to see what customer needs really are.  Armed with this knowledge, Silicom’s hit rate on new products is very high so its R&D efforts are very productive and efficient. 

After a small acquisition 6 years ago, Silicom developed a line of uCPE boxes used in enterprise branch offices.  These boxes are like switchblades, providing a variety of functionality in one device.  The most popular current function is software-defined networking or SD-WAN, which is growing at a 30% clip according to IDC.  SD-WAN allows branch offices to connect to the Internet in a more efficient way and save money versus the old way of connection which was through expensive MPLS (Multi-Protocol Label Switching) links.  This approach threatens service provider’s lucrative MPLS business and they are responding in different ways.  Silicom has won SD-WAN deals with both Verizon and AT&T.  While AT&T is aggressively trying to win SD-WAN business, Verizon has been more passive.  AT&T has become a sizable customer for Silicom while it is still waiting for Verizon to pick up the pace.  Silicom has also won designs with some major SD-WAN software vendors such as Velocloud, Versa, and Silver Peak, and is capitalizing on their growth now and into 2021.

Another growth vector for the company is the work they are doing with FPGA cards.  FPGAs (field programmable gate arrays) are chips that use parallel processing to calculate faster than CPUs and are used for calculation intensive functions such as artificial intelligence and autonomous vehicles.  FPGAs are also used in data centers and Silicom won a $10 million FPGA data center design win last year.  Silicom has been working on the FPGA opportunity for the past couple of years and while it has some revenue in 2020 from these products, more meaningful revenue will really start to ramp in 2021.

Finally, on Silicom’s last conference call the company disclosed a design win with a telecom service provider for DUs in its 4G/5G network buildout.  Silicom said that if this network rolls out as planned, it could mean tens of millions of dollars for Silicom from this win alone.  On a $100 million revenue base (in 2020E) company, that is very meaningful.  Traditionally networks were built by big proprietary vendors such as Nokia, Ericsson, and Huawei.  A new open standard has been gaining momentum where different building blocks of the networks are built by best-of-breed vendors.  This is called O-RAN (Open Radio Access Network).  Silicom is gaining its opportunity here because of this open approach.  Even Nokia and Ericsson are now participating in this standard and Silicom has an opportunity to become a DU supplier for them. 

Silicom is well positioned in the DU market because it not only designs the DU box itself, it also supplies important NICs that go into these boxes.  One NIC is based on Intel’s ACC 100 chip that performs forward error correction in the network, a highly compute intensive function.  Silicom is also finishing up work on a timing card that provides critical timing functions in the network.  DISH Networks has announced that it is working with Intel and its ACC 100 card in its new greenfield 5G buildout.  As Silicom is the only company with a working ACC 100 card, that means it is involved in DISH’s network, too.  This is an as-of-yet unannounced win but could be huge for Silicom in the years ahead.

Silicom’s valuation does not reflect any of these massive opportunities on the horizon.  On an enterprise value to revenue basis, the stock trades at 1.5x 2021E revenue of $130 million and at 13x 2021E cash earnings.  This is a valuation more fitting for a moribund no-growth business.  The company also has a pristine balance sheet with $87 million in net cash (which equals $12.22 per share).  I think the company can grow at a 25% clip through 2023, at which point it would be doing $200 million in revenue and $4.70 per share in earnings.  Putting a 20 P/E multiple on that and adding back the $12.22 in cash gets you to a $103 stock price, or 162% appreciation from current levels.    

Catalyst

A significant revenue and earnings beat in one of the upcoming quarters with get the stock moving.