PDF Solutions is a $695 million market cap technology company that helps its clients design and manufacture integrated circuits in greater volume, faster and at a lower cost. Its clients are fabless semiconductor design companies, foundries and integrated device manufacturers.
Its top three clients are Global Foundries, International Business Machines and Samsung Electronics. The driving force behind my investment thesis (beyond Moore’s Law) is the evolving trend toward very short product lifecycles and the need for greater performance in the consumer electronics space.
This is where PDF Solutions comes in. The company analyzes client manufacturing processes and tells them how to make chips faster and cheaper, while increasing volume. The result is a very specific and measurable improvement in client yield and financial performance.
PDFS’ business model is especially well suited to capitalize on the semiconductor industry’s needs today because it generates revenues in two ways.
The first is through its Design-to-silicon-yield solutions. This is typically a fixed fee for studying a client’s design and manufacturing process and offering solutions (process improvements and software) to improve yield and reduce costs.
The second is through what PDFS calls Gainshare. This is basically a performance incentive or profit sharing component if PDFS helps the client achieve certain yield and cost savings improvements. Gainshare usually kicks in after the set time for the fixed fee is over.
And Gainshare creates a lot of leverage in PDFS’s business model because these revenues have zero cost attached. As Gainshare incentives increase, PDFS profit margins go up.
Catalyst #1: Industry Trends—Shorter Life Cycle, Complexity, etc.—Supports Specialization
Demand for consumer electronics continues to push the semiconductor industry to design chips that are smaller, faster and more powerful. Yet these chips must also be more efficient, cheaper and available to the market with ever shorter lead times. Process professionals, like PDFS, can help.
I expect consumer demand will stay high for at least a couple more years. Additionally, newer technologies such as LED and 3D, and generally more complex manufacturing, should provide industry demand for IC manufacturing efficiency solutions. PDFS is in the sweet spot to capitalize on the opportunity.
Catalyst #2: Steady Growth
Like many companies, PDFS had its share of hard quarters during the financial crisis. But in 16 of the last 15 quarters, it has posted year-over-year revenue growth, averaging 21.5%. Thirteen of these sixteen quarters have seen sequential (quarter-over-quarter) revenue growth as well. Net income has also recovered since the recession.
The company’s balance sheet is healthy as well. It has zero debt and is sitting on $85.2 million in cash—that’s equal to 12.4% of the company’s market cap.
Catalyst #3: PDFS Still Unknown, More Exposure Should Help Share Price
PDFS is still relatively unknown. The company is small, with a market cap of just $695 million. There are just two analysts covering the stock. But those that do know how to evaluate companies based on financial performance metrics like the stock for good reason. This is why 65% of the company is owned by institutions.
Catalyst #4: Gainshare Profit Model Provides Leveraged Growth
Design-to-silicon-yield revenues make up 65% to 75% of revenues and have been growing consistently. It’s important to understand that, since Gainshare is tied to client yield and production volume, as production ramps up so too does this revenue source.
Catalyst #5: Possible European Recovery in 2014 Represents a Growth Opportunity
The region’s lack of growth represents a challenge to any company with exposure. In PDFS’ case, the negative impact is very easy to see by breaking revenues down by geography. European sales are significant, coming in at 24% of total revenues.
Over the last nine months, sales in Asia have surged by nearly 70%, while sales in the U.S. have grown a solid 7.3%. But sales in Europe are in the gutter, declining by 21.2%.
This is a large drag on growth for PDFS. But there may be reason for optimism—the IMF is expecting moderate growth of between 0.2% and 2% in 2014 from Europe’s five largest economies.
Putting it all together
Most of these catalysts are either industry-related or business model-related. There aren’t any specific and huge opportunities that PDFS is pursuing (that I’m aware of) that will have a transformative effect on the company in the near term. The opportunity here is a well run small company in a good industry that is taking care of business.
Tyler Laundon, The 100% Letter, www.100percentletter.wyattresearch.com, 866-447-8625, November 26, 2013
