RESEARCH REPORT-PXLW: OVERLOOKED, UNDER-APPRECIATED AND PERFECTLY POSITIONED FOR TECHNOLOGY SPENDING GOING FORWARD
Note: Insiders have been purchasing additional shares of PXLW as I have been writing this report. The insider buys are listed here http://finance.yahoo.com/q/it?s=pxlw
Pixelworks is a Silicon Valley based manufacturer of video and pixel processing semiconductors and software. As we all have found out over the past few years, video is increasingly becoming the killer application over the internet. Video demand is fueling a movement towards increasing quality of the images we view. Take for example the IPad Retina Display that delivers an extremely high quality image, increasing the viewing experience for the consumer. This type of increasing attention to portable video quality is just beginning to grab the attention of hardware manufacturers.
PXLW is positioned perfectly to take advantage of this movement. The company has been around since 1997 and once upon a time traded as high as $100 per share during the glory days of technology in the early part of 2000. Here is the official explanation of what PXLW does:
Pixelworks, Inc designs and develops system-on-a-chip semiconductors and software for broadband communications. It is a semiconductor company that designs, develops and markets innovative video and pixel processing chips and software for high-end display applications, including digital projection, large screen LCD flat panels and digital signage. Their solutions leverage proprietary core technologies that enable digital display and projection device manufacturers to differentiate their products with a consistently high level of video quality, regardless of the content's source or format. Pixelworks was founded in 1997 by Allen H. Alley and is headquartered in San Jose, CA.
Notes from their recent earnings report seem to confirm the fact that they are perfectly positioned going forward and present a compelling valuation proposition. The most exciting tidbit was the following:
Also in Q2, we achieved another key milestone as we won a significant co-development project with a major customer to develop a highly integrated next generation chip that will result in significant revenue impact in 2014 and beyond. This engagement is a significant positive for Pixelworks and reinforces Pixelworks’ market leadership position in video. In both of these engagements, Pixelworks was selected because of our industry leading display technology, recognized leadership in video quality, and world class execution capability.
"Significant revenue impact in 2014 and beyond." This in a company that is already trading at a heavy discount to present sales, let alone the discount that increased future sales provides.
More positive tidbits from the conference call:
Overall TV/Panel products came in at 28% of revenues and were up 166% year over year and 6% sequentially, driven by volume production of our PA Series products, and by the recognition of the 2nd phase of the license mentioned above. Projector products came in at 65% of revenues and were up 25% sequentially, reflecting the production ramp of Topaz products, and improving order patterns noted on our Q1 conference call
166% year over year tells you that their segment has just started to see a substantial pickup as the focus on video quality is coming into focus among hardware manufacturers. That focus among manufacturers is benefiting the companies bottom line. From the conference call:
Overall book to bill was much greater than one, as order patterns continued strong throughout the quarter, driven by new products ramping, resulting in visibility greater than normal going into Q3. Non-GAAP gross margin came in above the range of guidance at 50.6% and combined with below the range operating expenses of $8.1M, resulted in positive EBITDA for the quarter and cash generation from operations of $4.1M, a significant up-tick from Q1.
$4.1 million in cash generation for the quarter as a result of a dramatic increase in sales with the company already advising that a "significant revenue impact" of the positive variety is on the horizon. That cash flow you see here could very well double or triple in the years ahead, making the current valuation of some $50 million in total market capitalization seem absolutely absurd.
And here is the commentary that defines the position of PXLW going forward:
Video is increasingly the killer application, as consumption rises across all screens, small and large alike. The visual quality problems of large screens are migrating to small screens as video consumption grows and the visual user experience is increasingly the product differentiator. As the leader in creating the highest quality visual user experience, these trends are increasing the value proposition of Pixelworks’ technology.
Indeed there is a migration towards smaller screens. Already we are seeing advertisers, such as Facebook, have problems in maintaining their revenue models because their viewership is increasingly mobile. People are no longer tied down to their desks, instead demanding the highest quality mobile experience from smaller screens. This trend falls right into PXLW's lap.
The icing on the cake? Perfectly clean balance sheet, with cash on hand increasing substantially as a result of the cash flow gains we saw in the recent quarter:
Moving to the balance sheet, cash and marketable securities ended the quarter at approximately $15.1 million, versus $11.6 million at the end of the previous quarter. The nearly $3.5 million increase in net cash was due primarily to generating approximately $4.1 million from operating activities during the quarter reflecting the return to a more normal and linear revenue stream, including normalization of DSO and inventory levels. At quarter-end the Company had no long-term debt and a zero balance on its short-term line of credit.
I'm not done yet. There is also an insider buying binge that has been ongoing at the company for the better part of the past two years with prices as high as $3+ per share. It's not just the VP of Advertising doing the buying either. Top ranked officers at the company, including the CFO, have been aggressive buyers of the stock in this price range.
And then there is the activist investor angle. Becker Drapkin Management is headed by Matt Drapkin and Steven Becker. They are an activist value investor that allocates across numerous sectors. They have been aggressive buyers of the stock in the $2 range during late 2011.
Activist hedge fund investors don't necessarily guarantee a profitable outcome for investors. What the activist angle brings is one more potential catalyst, in terms of an investor who is aligned with shareholders in seeking appreciation of shares through management efficiency. It is akin to having the principal sit in on a classroom full of children. Throwing spit balls and handing out wedgies is traded in for attentive focus.
The combination of insiders buying alongside the activist investor is certainly reassuring. It tells an investor that both outside value managers and executives are spotting an opportunity based on available information. When searching through that information, I can see why the buying has been substantial on behalf of both parties.
This a relatively simple opportunity when you strip it down to its essence. You have a small company that is in the sweet spot of current consumer demand and as a result, the technology cycle. Their earnings are just beginning to expand, with the further promise of a substantial customer adding to revenue creation in the years ahead. PXLW is a company that has no debt, plenty of cash and the ability to generate substantial profits going forward. Insiders are buying a substantial amount of shares. A reputable activist hedge fund investor has joined the part as of 2011.
The technical picture is equally as bright:
click chart to enlarge
I'm having difficult coming up with an intermediate to long-term price target for PXLW based on available fundamental information. Technically, however, the target is clearly the 6-7 range outlined in the chart, making PXLW an easy 100% gainer from these levels. I don't see downside for the company below 2.20, meaning roughly 25% risk from these levels on the position. Exchanging risk of a quarter for the gain of a dollar is certainly not a bad proposition. And given what PXLW brings to the table the risks certainly seem weighted towards missing an outstanding opportunity in an overlooked company more than anything else.
Portfolio position information for PXLW is available here http://www.zenpenny.com/portfolio-update-15/
