1) Thesis Description

Vicor Corporation (VICR) is a manufacturer and supplier of modular power conversion systems for computing and electrical applications across several industries. The shift in electrical infrastructure from 12V to 48V systems is forcing high-powered computing (HPC), datacenter and EV automotive customers to reassess their suppliers to meet increasingly demanding power loads, allowing Vicor to gain large customer wins with their differentiated, advantageously designed products. Near-term coronavirus impacts should make the first half of the year fairly volatile until a 2H/20 ramp in production begins underpinned by long-term contracts that are not likely to be deferred. The company’s multi-year revenue growth trajectory should start in 2H/20 and accelerate through ’21-’23 given the long lead time from contract win to first production of their customers end products, supported by a 2x increase in manufacturing capacity. 

The thesis is as follows:

1)      At the current price of $43.24/share, the market assumes revenue growth slows from ~10% in ’20 to zero after two years. Valuation ranges from $31/share to $267/share, with scenarios ranging from no growth/margin expansion to ~25% market share of the HPC/AI chip market.

2)      An opportunity is available due to several reasons:

a.       Marginal investment community awareness as ~52% of Vicor is owned by Founder/CEO and the company only started conducting investor outreach in late ’19. Vicor is relatively underfollowed mainly due to the Founder/CEO’s large ownership position with a dual class share structure. Mr. Vinciarelli owns ~34% of Class A shares and ~94% of Class B shares (10x voting rights vs. Class A), equating to ~52% ownership and ~82% voting share. At ~45% of shares outstanding, VICR’s available shares amount to ~$900M and the large insider ownership/control relegates investors to a minority status, limiting the investor base. Despite having a market cap of ~$1.5B, the sell-side has not been incentivized to cover the company and historically the CEO never interacted with Wall Street. In a recent change in behavior, the company has indicated a few management personnel will attend several investor conferences going into ’20 and is now being covered by four sell side analysts, up from two earlier in ’19. Going forward, we anticipate investor interest increases with greater sell-side coverage, and the change in the company’s behavior is indicative of a plan to raise debt capital to fund their rapid expansion or shop the company to a strategic buyer.

b.       Trade dispute in ‘18/’19 and coronavirus in early ’20 has caused many Asian customers to moderate or delay capital spending into mid-late ’20, while future revenue growth should come from NAM, EU and Japan. In late ’18, intensifying trade disputes indirectly impacted capital spending plans in the Chinese computing market and a slowdown ensued. Further, a 20% import tariff on Vicor Brick products contributed to lower demand. Revenue from China/Hong Kong amounted to ~38% in ’18 and dropped to ~22% in ’19. As such, Vicor’s overall revenue growth declined ~10% in ’19, and temporary trade-related costs compressed operating profits an additional ~200 bps. With trade tensions at a standstill, revenue impacts should be normalized going forward. In early ’20, China and Hong Kong essentially shut down industry activity in an attempt to stymie the coronavirus outbreak and other Southeast Asian nations curtailed transactions with said countries. After the restart of China/Hong Kong in the coming weeks, Asian HPC/datacenter capital spending should modestly rebound in mid-late ’20 underpinned by the near-term trade détente and necessary catch-up from underinvestment. However, going forward the majority of Vicor’s future revenue growth is expected to come from HPC and datacenter customers in North America, Europe and Japan, not China/Hong Kong as in the past.

c.        Company’s inimitable market position underappreciated as computing infrastructure transition from 12V to 48V accelerates, after years of anticipation. Back in ’16, Google announced their intent to develop the next set of datacenter infrastructure designs with a 48V input as opposed to the existing 12V inputs, using Vicor products. With higher voltage inputs, distributing 48V power to electronics saves ~30% in energy costs while requiring less conductive material than 12V. Over the years, increasing datacenter and HPC/AI computing power demands are now forcing hyperscalers and processing chip manufacturers to fully shift their designs to 48V, rather than hybrid 12V/48V structures. Further, new use cases for high-powered computing, such as EV/autonomous vehicles and industrial manufacturing, increase the breadth of 48V end markets. Vicor anticipated the shift to 48V years before Google’s announcement and has developed unique, industry leading products for 48V datacenter infrastructure and HPC/AI chips. Notably, the company’s product differentiation is observable in its ~80% market share for 48V Application-Specific Integrated Circuits (ASIC) used in HPC/AI applications including its recent Nvidia, AMD and Intel contract wins.

d.       Revenue and margin growth trajectory questioned despite ~2x increase in manufacturing capacity by ’22 and end markets increasing over 20% per annum. For several years, management laid out the need to expand their ~$450M per annum manufacturing capacity as the 48V transition occurred in their end markets. In mid-’19, a minor ~$50M capacity expansion occurred and a new ~$250M capacity facility should be online by YE’20, totaling ~$750M capacity per annum. At present, the company is seeking to expand capacity an additional ~$250M to ~$1B per annum by ’22. Underpinning this expansion, Vicor has secured ~12 new HPC/AI design wins and multiple automotive and GPU contract wins in the last few years, most of which start production in ’20-’23. Beyond initial contract wins/startup, Vicor’s growth is strengthened by HPC and AI processor end markets that are anticipated to grow ~20% and ~50% per annum through ’25 coinciding with increasing power demands from growing computation intensity. Further, as the company scales manufacturing of higher-priced advanced products, operating margins should inflect upward from ~11% in ’20 to ~35% by ’25.

e.       Potential license partnership could accelerate adoption rates of Vicor 48V power components. Acceptance of Vicor’s highly differentiated products is partly impeded by a few large customers voicing concerns over the single-source supply of these necessary power components. Given the enabling characteristics of VICR’s converters for processor manufacturers, customer behavior is gradually changing on this pressure point. However, the company is exploring partnerships to license its technology to other manufacturers to alleviate customer concerns. With additional sources of supply, large customers would be more willing to shift to 48V with VICR or VICR-based products. Additionally, a license agreement could create a substantive royalty stream to the company.

f.         Long-term viability concerns overstated given large customer wins and 10-15 year R&D head start on 48V architectures as well as potential for acquisition in consolidating market. With recent key customer wins, Vicor’s advanced product design and market strategy has been proved-out compared to other market participants more pedestrian/safe product designs. Competitors aiming to encroach on VICR’s 48V analog designs should have a difficult time given the substantive IP developed over 10-15 years when the market was focused on 12V designs. Further, a consolidating competitive landscape over the last decade has resulted in a more concentrated and rational pricing environment for analog electrical component suppliers. Lastly, a specialized supplier such as Vicor would be considered a prime acquisition target in the consolidating semiconductor/electrical component market. These underappreciated market dynamics should aid in sustaining the company’s competitive advantage and margins into the future despite the industry’s history.

3)      The largest micro risk in the name is Founder/CEO retirement or capital misallocation, slow adoption of high-performance products, execution issues with manufacturing expansion and aggressive competitor responses. The largest macro risks are slower 48V transitions at hyperscalers/datacenters, downturn in HPC capital spending, trade disputes and technical obsolesce due to new technology.

2) Business Analysis

A Brief History – Firm Anticipated High-Voltage/Power Requirements for Leading Edge Computing

Vicor Corporation was founded in 1981 by Patrizio Vinciarelli, in Andover, MA, and focused on designing and manufacturing telecommunications power infrastructure, which utilizes DC distribution of 48V. In 1984, the company debuted a significantly enhanced DC-DC converter ‘brick’ compared to other offerings in the market. Through the ‘90s, Vicor became a leading vendor of brick DC-DC converters, with significant market share in the telecommunications sector.

In the early ‘00s, the company shifted to a mass customization strategy using highly automated manufacturing to serve customers with specific performance parameters that were not being met by large high-volume competitors. In parallel, Vicor began to invest significantly in two meaningful market trends, higher required conversion efficiencies and higher voltage/power requirements. This lead to the debut of Vicor’s Factorized Power Architecture (FPA), a modular rapid system design capable of higher density and power delivery than competitor’s designs.

From ’11-today, the company has expanded its portfolio to encompass power components from source to point of load with over 100 patents addressing high voltage, high power needs for semiconductors and their adjacent customer base (datacenters, high-powered computing/AI).

The company’s main manufacturing facility is roughly ~230K sq.ft and should have its ~90K sq ft expansion operational by YE’20, totaling ~$750M in per annum capacity.

Vicor has two business segments: Legacy and Advanced Products.

In ’19, revenue comprised of ~70% Legacy and ~30% Advanced Products. Geographically, revenue comprised of ~45% in the U.S., ~10% in Europe, ~25% in China/Hong Kong, 15%-20% in Japan/Other APAC and ~2.5% in other.

Legacy Products

The company’s Legacy products or Brick products consist of AC-DC and DC-DC converters and complementary components.

Advanced Products

Vicor’s Advanced products utilize proprietary magnetic structures, power semiconductors and microcontrollers to create a power conversion device that has superior thermal management and power density characteristics. These include AC-DC, DC-DC power converters, intermediate bus converters and voltage filter components. Additionally, several patented topologies, Vertical Power Delivery (VPD) and Lateral Power Delivery (LPD) decrease the distance between the processor, heat sink and voltage regulatory, thereby saving considerable circuit board space.

Notably, the company’s Non-isolated Bus Converter Module (NBM) allows customers to bridge their 12V and 48V systems, making it an optimal solution for those undergoing a 12V to 48V transition.

For Advanced products, efficiencies range from 90% to 98% compared to others 70%-85% efficiencies. As voltage and amperes increase in an electrical system, efficiencies decrease and Vicor’s advanced product efficiency advantages grow. Lastly, power density of the company’s advanced converters amount to ~10Kw/in^3, whereas competitors’ range 0.8-1 Kw/in^3.

Management History – Founder/CEO Owns Majority of VICR

Patrizio Vinciarelli, now age 73, founded Vicor in 1981 after a four-year fellowship at Princeton and before that a fellowship at CERN.  Dr. Vinciarelli personally holds over 100 patents including the patent for zero-current and zero-voltage switching, which enables Vicor’s power converters to be much smaller and efficient than the competition. Notably, much of his time is focused on working with the R&D team. Through his leadership Vicor has never had a layoff and is committed to internally developing personnel. Vinciarelli’s compensation comprises of a ~$390K base salary and an annual performance stock bonus of ~$1.6M or ~80% of total compensation. He owns ~34% of Class A shares and ~94% of Class B shares (10x voting rights) equating to an economic ownership of ~52% and voting share of ~82%.

James Simms, joined Vicor in ’08 as CFO, Treasurer and Corporate Secretary. Prior, he was a Managing Director of Investment Banking at Needham & Company and Janney Montgomery Scott. Mr. Simms compensation comprises of a ~$360K base salary and an annual performance stock/cash bonus of ~15% and ~30% of base salary. His long-term equity compensation includes ~0.135M shares (~0.2% ownership).

The executive team, including the Founder/CEO own ~55% of VICR.

Customer Dynamics – Changing Behavior Allowing Vicor to Make Inroads as Possible Sole-Source Provider

The company sells its products OEMs, ODMs and contract manufacturers typically for higher-performance, higher-power applications. Legacy products are sold to customers in aerospace, industrial automation equipment, medical device, rail transportation and test/measurement equipment markets. Advanced products are sold to customers in the datacenter and supercomputing segments of the computing market. Additionally, use cases for advanced products are growing to include aerospace/defense, networking equipment, solid state lighting and EV/hybrid/autonomous vehicle markets.

Legacy products are more commoditized and sold in low volume/high mix to their customers. Expected design cycles of customers utilizing legacy products is less than a year with product lifecycles close to a decade.

Advanced products are more specialized and are expected to sell in high volume/low mix to their customers. Expected design cycles of customers utilizing advanced products range from one to three years with product lifecycles close to three to five years. At present, Vicor has only a few advanced product customers, though is expected to have over 15 by ’21. Vicor has supplied a supercomputing customer for over 10 years with their advanced products.  

Given the smaller size of Vicor converters, customers are able to free up more pins on their semiconductors or power distribution networks than the competition. Also, the market leading efficiencies and power densities of these products address the largest pain point for high-powered computing applications namely power distribution losses and electromagnetic interference. Due to these factors, customers view the advanced converters as ‘enabling’ and not a commodity.

In the past, Intel had set the standard for voltages through a chip, and the entire ecosystem supplied products accordingly. Namely, stepping down a 12V supply to 1.3V-1.8V. Newer designs for HPC/AI GPUs by Nvidia and AMD are utilizing a 48V source stepped down to 0.8V or lower, changing the industry standards. The shift from 12V to 48V systems has allowed Vicor to make inroads with larger customers such as Nvidia, AMD and Intel as they reconsider traditional designs that are increasingly unable to meet the power demands for new processors.

As such, many customers have changed their behavior and plan to utilize Vicor as a single source provider. However, some large potential customers have also indicated concerns over a single-source supply. The company is evaluating plans to license their IP to a few manufacturers to alleviate supplier concerns and to accelerate adoption of their topologies while simultaneously pushing out potential competitors.

As for data center infrastructure customers, the shift in 12V to 48V power is expected to occur through several 3-year upgrade cycles and buying typically is more wide-based as opposed to single or second sources for ASICs.

Supplier Dynamics – Improving Supply Chain Visibility with Increased Scale and Exclusion of Chinese Suppliers

Vicor’s inputs comprise of multitude of raw material, commoditized ceramic capacitor and discrete semiconductor suppliers both internationally and domestically. Additionally, a portion of the company’s fabless manufacturing model relies on a limited number of wafer foundries and testing suppliers.

However, the geographic locations of the suppliers have changed substantively over the last several years primarily due to trade related disputes. Section 301 tariffs in ’18 caused shortages/higher costs for ceramic capacitors and discrete semiconductors from Chinese sources. Further, in late ‘19/early ’20, coronavirus related shutdowns in China limited supplies of necessary inputs. In response to tariffs, Vicor began sourcing these inputs from outside of China, a process which should be complete by mid-’20. A sound decision reinforced by recent viral outbreak issues.

Lastly, as Vicor expands the number of OEMs and programs under production, lumpiness in the supply chain should smooth out, while pricing power over suppliers should increase. This is in addition to improved visibility from no longer sourcing from China.

Competitor Dynamics –Rivals at Increasing Disadvantage with Higher Voltage/Power Levels, Consolidation Ongoing

The power component market supplying semiconductor manufacturers and datacenters is highly competitive and Vicor’s competitors are typically much larger and have significant share. However, many power component competitors are well established in the lower voltage sections of the market. Vicor stands out as having the widest array and highest quality power components at higher voltages and amperages.

The company has found that as chip manufacturers increase the amperage in their products above 400 amps (even up to 2,000 amps), the number of competing products quickly dissipates. This has led to Vicor winning over 80% of new contracts for HPC/AI ASICs, which can require at least 400 amps. 

Competitors typically attempt to reverse engineer others advanced designs and competition is expected to eventually increase in the higher voltage section of the power component market. However, Vicor maintains that its IP and 10-15 year R&D head start should enable them to stay ahead of others. Given the physical attributes of stepping up or bucking down voltage, analog power components typically exhibit longer life cycles and a slower pace of technological obsolescence than digital electronic components.

Notably, digital and GaN-based power components are substitutes at lower voltages/currents, while programmable analog power components have higher efficiency losses outside of their base design parameters. This further entrenches Vicor’s specific 48V high performance power component IP.

Over the years, competition has been fierce given the plethora of component suppliers to semiconductor manufacturers. Through each down-cycle, many have closed shop or merged allowing the largest (TXN, ADI, MXIM) players to gain share. With less players in the market, pricing should become more stable and those smaller, viable entities are likely prime targets for further consolidation.

For data center infrastructure, the 48V standard is being developed through the Open Compute Project, headed by Google and Facebook. With an open design structure, many other competitors are able to provide 48V point of load rack designs and Vicor is expected to have a small share of the 48V infrastructure.

Market Trends – Greater Computational Requirements and Growing HPC Markets, Use Cases Expanding

High-Power Computing

In ’18, the HPC server market grew more than 15% to ~$13.7 billion in revenue. The supercomputer segment (HPC systems sold for $500,000 or more) grew ~23% to ~$5.5 billion in ’18, the fastest growing competitive segment of the HPC market, according to Hyperion Research.

The AI processor market is expected to grow to ~$90B by ’25, a growth rate of ~50% per annum. Approximately 25% is expected to be toward data center deep learning applications. Notably, ASICs (Vicor’s largest new customer set) should amount to ~33% of all processors manufactured for HPC/AI, followed by ~20% FPGA, 15%-20% GPU/CPU and ~10% other.

Driving the growth in HPC/AI processors is the expansion of use cases beyond traditional IT applications including analysis of large data sets, manufacturing ops optimization, pharma research, 3D simulation and autonomous vehicles, to name a few.

Data Center Power Infrastructure

Front-end and central power solutions for data centers should grow ~15% per annum to ~$7B by ’23 comprising of ~$2B for 12KW-80KW rack power and 3 phase to 480V, ~$3B for 3 phase to 48V rack power, according to Technavio and Vicor.

Automotive

The automotive powertrain market for analog ICs is expected to grow to ~$6B by ’25 with a growth rate of ~9% per annum. By ’25, AI applications for autonomous driving should amount to ~$1B market.

48V Infrastructure

For computing and electrical applications, the transition from 12V to 48V is an increasingly necessary one. 48V systems have the benefit of increasing power to components without raising the current, while minimizing copper, cabling and power transmission losses. On average, switching from 12V to 48V lowers power consumption costs by ~30%, according to Google.

Vehicles were amongst the first application to adopt 48V, with hybrids in the ‘90s-‘00s. Google and others started a consortium called the Open Compute Project in ’11 to standardize 48V systems for data centers. By ’16, many semiconductor manufacturers and suppliers were starting to design and produce 48V based systems.

With processors decreasing in size (transistor distances down to 5nm) but increasing in power needs and data centers/EV need to minimize power consumption, 12V is becoming increasingly disadvantaged compared to 48V.

As for future electrical system paradigm changes, anything higher than 60-volts not only breaches Safety Extra Low Voltage (SELV) requirements, but becomes more expensive to implement. Designers would need special cabling and wiring to create a system safe for humans to manage and regulatory oversight would also increase. 48V systems appear to be in a sweet spot for many of these power hungry applications.

3) Why now?

Vicor was a historically middling niche power component manufacturer. The Founder/CEO adroitly reallocated capital from this small scale, commoditized core business to develop enabling solutions for 48V architectures. The shift from 12V to 48V should enable the company to gain share and a defensible position in a wider array of end markets utilizing high-intensity computing. We advocate entering into a position as the company recovers from trade dispute/coronavirus impacts and begins a multi-year growth trajectory manufacturing high-margin 48V power solutions to its fast growing customers.

A few key points below illustrate the company’s value potential at this point in time:

1)      Revenue Growth at Inflection Point as Transition to 48V Architectures in Early Stages of Adoption: In ’16, Google announced its plan to shift their entire rack/server base to 48V. However, industry adoption of 48V architectures has lagged given the increasingly long time to design new 48V components along with hesitancy from other datacenter competitors. With increasing power demands for datacenters and HPC applications, the cost savings and efficiencies by using 48V designs is becoming mandatory to stay competitive. In early/mid-’20, Vicor should initiate production of several 48V-based designs for HPC/AI applications. Through ’23, the company anticipates scaling production backed by over 15 contracts for 48V-based components from Nvidia, AMD, Intel and others. Additionally, the en-masse shift to 48V infrastructure for datacenters should coincide with the next few datacenter hardware upgrade cycles (’20 and ’23 or ’24). Evidence of this upward inflection in growth for 48V solutions is underpinned by Vicor’s expected manufacturing capacity additions from ~$450M in ’19, scaling to ~$750M by YE’20 and over $1B by ’22. We anticipate the company grows revenue at a lagging cadence to manufacturing capacity increases through ’25, and moderates thereafter.

2)      High-Powered Computing Demands Greater Efficiency from Analog Components, Where Vicor’s Unique Product Offering is Far Ahead of Competition: As processors increase in density and computational capacity, power demands surge and most importantly, efficiency losses rise to the square power. Therefore, the defining characteristic for power conversion components in leading edge of HPC/AI processors is power delivery efficiency and lower EM noise. With 48V base voltage, currents above 500 amps are more easily delivered, and HPC currents are starting to exceed 2,000 amps. Vicor’s 10-15 year development of new analog 48V power conversion products for advanced computing and data center infrastructure applications created a substantive head start compared to competitors. As such, VICR offers a wide array of 48V-based analog power conversion components with best in class efficiencies (95%+ average) and low EM noise characteristics at high amperage. Notably, the company’s competitive position is exhibited by minimal competition on RFP’s for high amp (400-2,000+ amp) power applications.

3)      Expanding Use Cases for High-Powered Computing (IoT) Creates Revenue Diversification, Decreased Pricing Power from Customers: As HPC/AI expand into industries beyond pure IT, namely those looking to digitize operations and increase efficiencies (industrial, auto, IoT applications), the semiconductor industry should be exposed to less pricing pressure as there should no longer be one core end market with customers operating under similar business cycles and requiring similar technical specifications. As a consequence of this end market diversification, suppliers such as Vicor should also experience a lower level of pricing pressure going forward and supply a customer base reaching a larger serviceable market.

4)      Substantive Operating Margin Expansion as Manufacturing Scales and Portfolio Shifts from Legacy to Advanced Products:  Vicor’s predominantly North American manufacturing locations are highly automated and at expected ’20 production volumes (~50% utilization) are operating slightly above fixed cost levels. As manufacturing volumes grow, factory utilization levels should increase and the operating leverage should drive margins higher. Additionally, the company’s margin expansion is aided by higher margin Advanced products growing to ~50% of revenue by ’21 and almost 80% by ’25 as lower margin Legacy products only grow at or below GDP levels. Further, with greater scale the company’s products should increase in cost competiveness and de-risk customer concerns over component supplies. Given these factors, Vicor’s operating margins should expand from ~11% in ’20 to ~35% in ’24 (~80% utilization).

5)      Industry Consolidation Sets the Stage for More Rational Market Dynamics: The analog semiconductor industry has been consolidating for over 10 years with Herfindahl index (HHI) increasing from ~750 in ’10 to over 1,500 in ’19 roughly the threshold of a moderately concentrated market, giving way for more pricing power in the future. This is exhibited in the largest five analog manufacturers (ADI, ON, MCHP, MXIM, TXN), which have seen their combined market share grow to ~60% and operating margins expand ~ 1,000 bps over the past five years. Additionally, ongoing consolidation makes a smaller, niche company such as Vicor a prime acquisition target given substantive manufacturing cost synergies and a competitive product portfolio.

6)      Founder/CEO Concentrates on Long-Term, Focus on R&D Entrenches Competitive Position: The Founder/CEO, given his unique technical skills, positioned the company for a 48V future. Essentially the commoditized Legacy business generated capital that was redeployed for 10-15 years in R&D to develop a unique set of solutions for 48V applications. Analog power components tend to have greater barriers to entry and are harder to replicate making IP moats more sustainable. This head start in R&D and the nature of analog components should allow Vicor to entrench itself and improve its position over time with greater customer acceptance and further R&D spending.

7)      Recent Sell-Side Coverage May Indicate Search for Founder/CEO Exit or External Debt Capital Raise to Fund Rapid Growth: Vicor has been public since the ‘90s though sell side coverage and coinciding investor outreach only really began in ’19 as the CEO indicated his intent to focus on the business and not Wall Street. Starting this year, the CFO plans to attend several investor conferences and sell side coverage is increasing. This change in behavior may indicate a few potential actions. With the large ramp in manufacturing capacity pending and the unlevered balance sheet, the company may be attempting to gain greater visibility to raise debt to fund growth. Another possibility could be marketing the company to allow the Founder/CEO, who is 73, a chance to exit his ~52% ownership via acquisition by a strategic buyer.  

4) Concerns/Thesis Pressure Points

New Product Risk

Vicor is in the midst of selling highly advanced products to a customer base which has not fully adopted 48V designs and not solidified around supply sources. Failure to gain sustained traction in new products would be detrimental to the company’s growth and future capital plans aimed at increasing manufacturing capacity.

Technical Obsolesce Risk

Semiconductor components are continually being improved and redesigned, shortening their life cycles. Analog components exhibit longer life spans than digital components, though still require continual R&D to maintain their competitive position.

Competition Risk

As 48V architectures gain in acceptance across the computing industry the number of component providers is expected to increase. The company currently has ~80% of 48V ASIC contracts from big customers such as Nvida, AMD and Intel. However, Vicor conservatively estimates it should ultimately hold ~10% market share in its respective markets due to competition from larger entities.

Founder/CEO Risk

Vicor’s Founder and CEO owns ~52% of shares outstanding and given the Class B voting rights, has ~81% voting power. Investors are therefore in the passenger seat to the CEO’s capital allocation decisions. Further, the CEO is 73 years old and succession risks (retirement, selling the company) may impact operations.  However, an elimination of Class B shares and any other transitions to better corporate governance would be seen as beneficial.

Market Cycle Risk

The company’s datacenter end markets typically have 3-4 year upgrade cycles and computing end markets exhibit a high degree of cyclicality. However, with the expansion of HPC/AI use cases in industrial and automotive end markets and industry consolidation, cyclicality going forward should be less acute.

Trade Dispute/China-Hong Kong Risk

Vicor’s revenue from China/Hong Kong is ~22%. Trade tensions caused significant downdraft in revenue and supply chain costs in ‘18/’19. Should trade disputes intensify VICR could be negatively impacted. Additionally, recent protests in Hong Kong as well as coronavirus quarantine measures amplify near term risks.

5) Business Valuation

Vicor should exhibit solid double digit growth over a number of years as the company ramps their production to meet contracted demand for HPC/AI processing chips and data centers as they shift to 48V architectures. The company generates revenue through the manufacture and sale of specialized analog power components.

A summary of the Base Case assumptions for the company is below:

1)      Short-Term Guidance ’20: Revenue: 1Q slightly above 4Q, large ramp in April. Possible Advanced Product supply constraints due to China suppliers through 1Q.

2)      Long-Term Guidance: Revenue Growth: DD per annum, Gross Margins: >65%, Operating Margins: >35%.

3)      Total revenue should grow ~15% to ~$305M in ‘20, and ramp 25%-30% per annum to ~$1,000M by ’25, then slow to ~10% growth in ’26 as contract growth stabilizes.

4)      EBITDA margin of ~14% in ‘20 should improve to ~38.5% by ‘24, a ~490bps expansion per annum.

5)      Capex: ~$18M in ’20, ~6% of revenue through business expansion (’23) and ~3% of revenue thereafter.

6)      ~16.5x normalized EV/EBITDA multiple for Vicor. Reasoning behind the multiple is in the Peer Analysis section below.

7)      Discount rate at ~12.5% (mid-cap).

Five-Year Operating Model

A simple five-year operating model is utilized to determine value.

Base Case:

Base Case assumes the company grows to ~$1B by ’25 and expands operating margins ~38.5%.

-           Base Case Valuation: $95.50/share.

Upside Case:

Upside Case assumes the company grows to ~$1B by ’23 and captures ~25% of its serviceable markets (~$2B) at maturity.

-           Upside Case Valuation: $267/share.

Downside Case:

Downside Case assumes the company does not grow or expand operating margins.

-           Downside Case Valuation: $31/share.

Peer Analysis – Trading Comps

Vicor has a few direct public comparables, many of whom have overlapping exposures to analog components supplied to electronics and semiconductor manufacturers including, Analog Devices (ADI), Monolithic Power (MPWR), Maxim Integrated (MXIM) and Power Integrations (POWI). Analysis below utilizes a normalized EV/EBITDA metric to account for the margin implications of business model shifts.

Public Comparables – EV/EBITDA

1)      Analog Devices (ADI) – ~14x normalized EV/EBITDA; currently at ~17x FTM.

2)      Monolithic Power (MPWR) – ~21x normalized EV/EBITDA; currently at ~32x FTM.

3)      Maxim Integrated (MXIM) – ~12x normalized EV/EBITDA; currently at ~16.5x FTM

4)      Power Integrations (POWI) – ~16.5x normalized EV/EBITDA; currently at ~20x FTM.

Analog Devices designs and manufactures high-performance analog, mixed signal, digital signal processing technology. Approximately 20% of revenue is derived from power management component sales, of which they command ~11% market share in voltage regulators (#2). The company is developing solutions for 5G connectivity, automotive and industrial applications. Notably, over one-third of its revenue comes from analog components developed over 10 years ago. Growth is expected to average ~6% per annum over the next five years.

Monolithic Power designs and manufactures integrated power semiconductor solutions and power delivery architectures. The company is a direct competitor to Vicor. MPWR is developing power solutions for automotive, data center and industrial applications. Monolithic touts a variety of 48V automotive and datacenter products, though most are programmable analog components which lack performance outside initial design parameters. Growth is expected to average slightly above 15% per annum over the next five years.

Maxim designs and manufactures a range of linear and mixed-signal integrated circuits. The company is a direct competitor to Vicor. Approximately 20% of revenue is derived from power management component sales, of which they command ~5% market share in voltage regulators (#4). The company is developing solutions for datacenter, automotive and industrial applications. Growth is expected to average 0%-5% per annum over the next five years.

Power Integrations designs and manufactures analog and mixed-signal integrated circuits. The company is developing solutions for consumer electronics, communication, industrial and transport applications. Growth is expected to average ~10% per annum over the next five years.

The group’s normalized EBITDA multiple equates to ~16.5x and has ranged between 9x-29x from ’05 to ’19 and currently trades at ~21x FTM assuming ~8.5% per annum revenue growth. Vicor currently trades at ~40x FTM EBITDA and has ranged between 9x-50x from ’05-‘19.

Peer Analysis – EBITDA Margins

EBITDA Margins

1)      Analog Devices (ADI) – ~45% normalized EBITDA margin; currently at ~48% FTM.

2)      Monolithic Power (MPWR) – ~32.5% normalized EBITDA margin; currently at ~27% FTM.

3)      Maxim Integrated (MXIM) – ~35% normalized EBITDA margin; currently at ~37% FTM

4)      Power Integrations (POWI) – ~22.5% normalized EBITDA margin; currently at ~22% FTM.

Analog’s operating margins have increased ~350 bps per annum since ’14 and are expected to remain below 50% for the next five years. Capital expenditures have averaged ~4.75% of revenue.

Monolithic’s operating margins have increased ~90 bps per annum since ’12 and are expected to stabilize for the next five years. Capital expenditures have averaged ~6.75% of revenue.

Maxim’s operating margins have increased ~140 bps per annum since ’14 and are expected to expand 100 bps per annum of the next five years. Capital expenditures have averaged ~2.75% of revenue.

Power Integration’s operating margins have declined ~50 bps per annum since ’13 due to increased R&D expenditures and are expected to remain at current levels for the next five years. Capital expenditures have averaged ~5.5% of revenue.

Vicor’s comparable group generates ~33.75% normalized EBITDA margins, underpinned by operating margin expansion of ~130 bps per annum. Vicor is expected to expand EBITDA margins over 400 bps per annum from ~17% to ~38.5% by ‘24, slightly above Maxim’s normalized margin profile.

Strategic Acquirer Analysis

Precedent Transactions

1)      Integrated Device Technology (IDTI, analog mixed signal) – 7x EV/Revenue, ~22x EV/EBITDA (30%+ EBITDA margins), ~15% per annum growth (late ’18 to Renesas)

2)      IXYS Corp (IXYS, power semis) – 2.2x EV/Revenue, ~8x EV/EBITDA (15% EBITDA margins), ~5% per annum growth (early ’18 to Littlefuse)

3)      Linear Technology (LLTC, analog power IC) – 9.1x EV/Revenue, ~19x EV/EBITDA (~48.5% EBITDA margins), 5%-10% per annum growth (early ’17 to ADI)

4)      NXP Semi (NXPI, analog mixed signal, power semi) – 3.8x EV/Revenue, ~14.5x EV/EBITDA (~25% EBITDA margins), 7%-10% per annum growth (late ’16 to QCOM)

Precedent transactions for analog IC firms show that valuations ~16x EBITDA, roughly in line with public comparables. From this selected data set, higher EBITDA margin (25%+) manufacturers are clearly valued at a higher multiple (~18.5x) than lower margin competitors (sub-10x).

Peer Analysis – Conclusion

For Vicor, a ~16.5x EV/EBITDA normalized valuation appears reasonable based on public and transactional comps. However, should Vicor prove out its growth profile (revenue: ~$265M to $1B in 3-5 years), the market would likely apply a normalized EV/EBITDA multiple around 20x-25x during its growth phase, a 25%-50% premium.

6) Market Expectations/Perceptions

Vicor’s is covered by 4 analysts with an average price target of ~$49/share. All the analysts have a Buy rating. Investor commentary highlights the specialized nature of VICR’s 48V solutions and the expected long-term growth trajectory. With increasing sales from 48V and HPC/AI customers, investor interest in the company should increase as it proves out its new products.

Enthusiasm around VICR’s growth prospects is evident in its ~40x EV/’20 EBITDA multiple, well above our expected growth multiple of 20x-25x. However, the company trades at ~20x EV/’21 EBITDA in line with our growth phase multiple due to expected ramps in production.

Consensus forecasts ~15% revenue growth in ’20 accelerating to ~20% and slowing to ~5% in ‘21/’22, and EBITDA expansion of ~600 bps per annum to ~23% in ‘22. Notably, we are slightly below ’20/’21 revenue growth consensus but above’22 as we anticipate an acceleration from new contract wins.

7) Downside Protection – Where’s the Margin of Safety?

At $43.24/share, the market assumes revenue growth declines from ~10% per annum to 0% after two years and operating margins remained subdued at ~20%. Further, the current market price implies a ~40x EV/’20 EBITDA, above our expected valuation multiple during VICR’s growth stage. However, the company does trade at ~20x EV/’21 EBITDA, in line with our expected growth stage multiple.

Aside from an elevated valuation in anticipation of rapid growth, investment in Vicor is protected on the downside due to the company’s niche in 48V and the semiconductor industry’s consolidation. A sale to a strategic buyer assuming ~35% EBITDA margins and a run-rate $750M-$1,000M in sales, could yield a purchase price of $100-$155/share (16.5x-18.5x).

8) Conclusion       

Vicor is a specialized semiconductor supplier on the cusp of rapid growth due to a market leading portfolio of 48V power solutions. As the HPC/AI and data center industries increasingly shift to 48V, the company’s competitive position should become evident making it more valuable to both its customers and investors.

Lastly, any joint venture or partnership to alleviate customers concerns around single source supplies could de-risk the name significantly as well as lower barriers to convert to 48V.  

As of February 28, 2020, the name is trading at $43.24/share. With a Base Case valuation of $95.50/share, we believe there is ~120% upside, equating to ~17% annualized IRR over a five year time horizon.