Omnivision (OVTI) is a fabless semiconductor company that focuses on designing imaging chips for (mainly) consumer electronics.
In the words of the company:
Its image-sensing devices, referred under the name CameraChips, are used to capture an image and used in various commercial and consumer mass-market applications. The CameraChips are used in various consumer applications, such as camera cell phones, digital still and video cameras, personal computer camera applications, and interactive video and digital toy cameras. In addition, CameraChips are integrated into security and surveillance products and analog toy cameras, automotive products, and medical imaging devices. Further, it designs and develops software drivers for various computer operating systems, as well as embedded operating systems.
OVTI is trading near $13.60 and has a market cap around $750 million, thanks to Friday's 16% plunge off an earnings report. Part of the reason attributed to the drop was fears about pricing pressures hurting margins. Contracting margins are pretty much implied whenever you talk about semis, and although OVTI has experienced that over the last several years earnings and cash flow have continued to grow at a rapid clip, with adjusted net income doubling and adjusted free cash flow tripling in the last three and a half years. Based off market cap., OVTI trades for 8.5x trailing earnings, and 8x trailing free cash flow. But market cap only tells half the story; as Omnivision has over $380 million in net cash, or about $7 per share - this means you are getting nearly half of your share price in cash. Now when you consider that Omnivision actually has an enterprise value of $360 million, the stock is actually trading for under 5x earnings and under 4x free cash flow... both of those numbers are phenomenal.
Just because OVTI appears dirt cheap doesn't mean its a bad company, on the contrary, it has generated nearly $100 million in annual free cash flow over the last few years. Omnivision also has developed a new chip that changes the way autofocusing is processed, which allows for much quicker and clearer imaging. The all-digital process has the potential to eliminate any sort of manual focusing traditionally done with cameras, and I'm fairly sure that somewhere in my research I read that Omnivision has patentied the technology, which should be ready for commercial use within a few quarters. The company's expansion in security and medical imaging is also offering growth opportunities beyond the consumer electronics market of cameraphones and video recorders, so there is plenty of potential growth on top of that excellent financial footing.
Running a quick revenue and earnings projection concludes that top line growth of 15% over the next 5 years is manageable, with net income growing about 17% over that time period. The lastest consensus estimate from Wall Street was 20%, but I think you are going to see some waffling because of the quarterly disappointment... and I like to be conservative.
According to the valuation model, OVTI is priced for no free cash flow growth over the next five years, and has a terminal valuation of 5x FCF. Recall that OVTI is trading for just under 8x FCF right now... which I believe is extremely cheap in itself. But anyways, from the reverse engineering standpoint, OVTI is priced as being a company that will see no more growth, and will end up being valued at a 20% free cash flow yield. Think those pricing assumptions give you some margin of safety?
On the more realistic (but still conservative) side of pricing, lets assume that Omnivision manages to grow free cash flow at about 10% per year, or about 60% of what is forecast by a quick growth projection (I choose 60% because that leaves a 20% margin of safety and 20% for "excess return"). At 10% growth, and an end cash flow yield of about 15% (which matches the steep 15% discount rate I am applying to account for riskiness), OVTI appears to be an $18-19 stock, which would give an appreciation of about 35%.
If we increase our assumptions about the growth rate for Omnivision to 12%, and allow for an exit multiple of 8x FCF, a 15% discount rate results in OVTI being valued around $21, or a potential 50% gainer. I would argue, however, that OVTI's recent sharp drop coupled with the huge cash position makes OVTI less of a risk now, and worthy of a lower discount rate - 12% for the discount makes OVTI appear to be 75% undervalued. Basically, its hard to justify this stock going much lower, and very easy to see this one running up toward $20.
One additional fact to note is that Omnivision does an exceptional job at creating value from invested capital; EBIT RoIC was 100% over the last four quarters. Although RoIC has been slipping slightly on a sequential basis, taking a slightly longer term time frame sees free cash flow RoIC climbing from 28% three years ago to over 75% today. This means, in simple terms, that for each dollar Omnivision has invested in its business today, it returns 75 cents in cash after everything else is accounted and paid for. Omnivision hasn't been skimping on spending for the future either; outlays for Research and Development and Capital Expenditures continue to increase, and as long as Omnivision can continue generating such high returns on capital, it looks to be well positioned to continue growing its bottom line.
Final thoughts: I think its a strong buy in the mid-$13s where it is now. If it goes lower, that just makes it look even more attractive.