Description
Intellon Corporation
Summary:
I am recommending a long equity position in Intellon Corporation (ITLN), which presents a near-term risk/reward proposition of 30% to 50% in next six months. ITLN is a fabless semiconductor company that designs and sells integrated circuit (ICs) for high-speed communications over preexisting electrical wires without any new wiring. ITLN is the innovator in this field and has no competition yet in its space. With proliferation of digital video, audio, and data content into home entertainment, I believe a long investment in ITLN is timely and possibly highly profitable even in current market conditions. With net cash on the balance sheet greater than its market capitalization, we are acquiring this niche and monopolistic business for free considering that the business is profitable on both net income and cash flow basis. Additionally, there are $65 million in NOLs that make this net-net very attractive in the current environment.
Long Thesis
Niche Industry
- Intellon chips enable home connectivity, sharing and moving content among PCs and other electronic products in home and commercial dwellings over electrical wiring and coaxial cables. No new wiring is required as Intellon chips operate with preexisting wiring and no new wiring is necessary. At present, Intellon is only company with such products with strong patent protection.
- ITLN's products are gaining traction in smart grid utility applications with a boost from Obama's new energy initiatives.
- Apart from patent issues, new competitors will have to test their products with customers for greater than 18 months, which is a significant barrier-to-entry.
Net Cash greater than current market capitalization
While company's net cash and equivalents at end of FY 2008 was $56MM and current market capitalization is $ 48 MM. Additionally, the company has greater than $ 65MM in NOLs.
Profitable Business
The company reported a profitable year for 2008 on GAAP basis with gross margins greater than 40%. Company reported positive EBIT starting 2008Q3. Since IPO in 2007, the company's cash and cash equivalents have increased. This gives me confidence that the company may not burn cash irresponsibly.
Expanding Markets
There is a rapidly growing market for simple reliable connectivity in digital home. ITLN's technologies coexist with various wireless technologies in this space.
Fabless Operations
Due to its fabless operations, ITLN has relatively better control over its costs.
Prudent and Conservative Management
I found top management is shareholder friendly with focus increasing value of the business in the long term. Furthermore, Charles Harris, CEO is disciplined and with background in securities industry. During a recent conference call, Mr. Harris stated that he would not hesitate to sell the company if offered a fair price. None of the company insiders have sold the stock in the market after IPO, and now with such depressed stock price and high insider ownership, I believe, the management will do the necessary to increase the shareholder value.
Valuation
After years of development of its IP, the company has experienced 14 successive quarters of sales ramp.
|
(in $MM)
|
2008Q4
|
2008Q3
|
2008Q2
|
2008Q1
|
2007Q4
|
2007Q3
|
2007Q2
|
2007Q1
|
2006Q4
|
|
Revenue
|
20.8
|
20.1
|
18.1
|
16.3
|
15.7
|
14.5
|
12.4
|
9.7
|
8.9
|
|
Gross Profit
|
8.8
|
8.2
|
7.8
|
7.3
|
6.8
|
6.2
|
5.9
|
4.2
|
4.2
|
|
GP%
|
42.3%
|
40.7%
|
43.2%
|
45.0%
|
43.6%
|
42.8%
|
47.6%
|
43.3%
|
47.5%
|
ITLN currently trades at
- Discount to cash of $56 MM per FYE 2008
- Approximately 65% of tangible book value
- P/S = 0.66
The following facts serve as a basis in estimation of ITLNs fair value.
- Top line organic business growth of greater than 25%
- Gross profit of greater than 40% and positive EBIT in a tough 2008 environment
- Shareholder friendly management with no insider sales and large insider position
- Large cash position, hence minimal impairment risk
- Growing market as consumer preference changes to digital media
- With customers spread uniformly across the globe, there is minimal customer concentration
I am comfortable with 10 times of my estimated 2009 earnings multiple implying current baseline valuation of approximately $2.50 (~$1.81 in cash + ~$ 0.65) per share.
In addition ITLN has a shareholder friendly management with no insider sales and large insider position. Also, future expansion into utility sector provides additional upside optionality.
Risks
- Management burns a large portion of cash irresponsibly. However, I believe the likelihood of this event is remote as I found management to be cognizant of the concerns of external shareholders.
- Small capitalization stock with limited product diversification.
- Core earnings significantly less than my expectations in the future.
Catalysts
- A larger company takes out ITLN as alluded to in 2008Q3 conference call. I believe this event is likely and the takeout value may be much larger than my baseline estimate.
- Continued top line ramp contributing to its bottom line.
- Street recognizes that the business is trading below its cash level and large discount to its book value.
Catalyst
- A larger company takes out ITLN as alluded to in 2008Q3 conference call. I believe this event is likely and the takeout value may be much larger than my baseline estimate.
- Continued top line ramp contributing to its bottom line.
- Street recognizes that the business is trading below its cash level and large discount to its book value.