model

Himax Technologies: Fabless Model Not Working So Well (NASDAQ:HIMX)

Small-cap ($658 million) Taiwan based Himax Technologies (HIMX) is a 30-year old company that specializes in display technologies and human interfaces. On October 6, the company announced preliminary Q3 results that were bullish. The stock popped 10%+ on the news, but is still trading more than 20% below where it was earlier in the year prior to the global pandemic. Yet I think the stock is no bargain and here’s why.

The Q3 Preliminary Update

The preliminary Q3 report (unaudited) was bullish for the following reasons:

  • Q3 revenue of $239.9 million would be +28.3% sequentially (+46.1% yoy) and significantly higher than previous guidance (+20%).
  • Gross Margin was ~22.3%, exceeding the guidance and +130 basis points sequentially and +280 basis points from 19.5% in Q3 of 2019.
  • IFRS earnings expected to be around $0.049/ADS, exceeding the guidance and +510.0% sequentially and +217.1% yoy.

Mr. Jordan Wu, Himax President and CEO, commented:

We are seeing continued strong business momentum across all our major business sectors in the fourth quarter. We will give further details in the next earnings call.

The next earnings call will be sometime in November but that date has not yet been announced.

Q2 Earnings

Going back a quarter, note the Q2 EPS report was nothing to crow too loudly about but was solid given the global pandemic:

Source: Q2 EPS Report

As can be seen by the graphic above, revenue was +1.3% sequentially and +10.4% yoy and Himax was able to swing from a loss of 3 cents in Q3 of 2019 to a gain of $0.008/ADS.

One reason for the very low profit per share is simply the massive number of shares in comparison to revenue and profit. Seems like if there was ever a case for a 10:1 reverse split, Himax would be Exhibit #1.

Regardless, what I noticed about the EPS report was the inordinate cost of revenue in relation to revenue (79%). When you add in R&D expenses (15%, not unreasonable for a tech company), the aggregate is 94% and that doesn’t leave a lot of room for profitability. That’s likely the reason why the company has been working to reduce SG&A – progress on that front (in aggregate ~$1.4 million less as compared to Q2) certainly helped bottom-line profitability.

Going Forward

The main issue with Himax is that it is a fabless company that depends on ICs for a large percentage of its revenue, and that proportion of sales grew last quarter as non-drive products shrank by almost 20%. In Q2:

  • Large driver ICs: 31.8% of revenue, -3.1% qoq
  • Small and medium-sized driver ICs: 52.8% of revenue, +12.9% qoq
  • Non-driver products: 15.4% of revenue, -19.5% qoq

That is, 84.6% of revenue came from ICs, and that proportion is growing, and that proportion is the overwhelming “cost-of-revenue” input for the display driver company.

That may explain the stock ownership levels:

Source: August Presentation

While it is nice to see such high insider ownership, the lack of institutional and mutual fund investors likely has as much to do with the fundamental fabless business model as it does with the company’s small market-cap. After all, the fabless model can work if the ICs being designed are full of high-value IP and can be bought/sold with a healthy profit margin. Note a company like Vicor (VICR) has a very successful fabless model. That’s because its ICs are highly proprietary and value-added so that, in Q2, its cost-of-revenue was only 57% of total revenue as compared to 79% for Himax. See Vicor: Powering Nvidia’s New A100 Tensor Core GPU. That’s a huge 22% delta, and while Vicor is an extremely successful company that may not be a fair comparison – you get the point: highly valued IP-rich ICs can be sold at greater margins than lower-valued display drivers – even if they contain Himax proprietary technology – because there are competitors that run their own fabs.

Himax is a highly technical company with over 2,900 patents (500+ pending), ~90%+ of employees are engineers, and 9 global design centers (Taiwan, China, US, Israel, Japan, Korea). What’s interesting is that the company has its fingers in a lot of various pies (see graphic below), yet with all that engineering talent and global R&D footprint, it can’t seem to hit on those one or two home-run type inventions/products that can lead to a “break out” in earnings and, subsequently, in the stock price.

Source: August Presentation

As a result, Himax may have the third highest market share in display driver ICs (8%), but that is behind Samsung (OTC:SSNLF) (29%) which obviously fabricates its own ICs and can therefore compete very effectively against Himax because it has no middle-man to take out margin.

And while Himax does seem to be growing market share in tablets and autos, again, it seems like other companies (Texas Instruments (TXN) and NXP Semiconductors (NXPI) in autos, for instance) with their own fabs will be able to drive down prices and thus compress margins for a fabless company like Himax.

Summary and Conclusion

Himax apparently has some very good technology but it struggles to leverage that technology into bottom-line results. What the company needs is a home-run product, protected by proprietary IP, that would enable it to cut out any competitor that operates its own semiconductor fab. Otherwise, margins will continue to be skimpy. As a result, it’s hard to get bullish on the stock because the cost-of-revenue added to the R&D expense needed to stay on the leading edge of display technology likely won’t leave much leftover for shareholder returns. Which is likely the reason the stock is down ~50% over the past 5 years:

Source: Seeking Alpha Charting Tool

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am an engineer, not a CFA. The information and data presented in this article were obtained from company documents and/or sources believed to be reliable, but have not been independently verified. Therefore, the author cannot guarantee their accuracy. Please do your own research and contact a qualified investment advisor. I am not responsible for the investment decisions you make.

Source Article