ChipMOS: 20-30% discount w/ 20% FCF yield would not last w/ 2Q14 hard catalyst

Baupost is already there as it owns 9.7%, but I expect as more look at MU, they will see IMOS as well and be as interested as I am. One of my best small-cap ideas for 1H14. The increasing hype behind Ultra HDTV should help people discover this gem too. I'm playing for $30/share, but who knows, it could way overshoot.

ChipMOS (IMOS, $19.5, ~575 mm market cap)

It’s cheap, sits on 200-250 mm in net Cash (from 275 mm net debt 5 years ago), 2.7x EV/EBITDA (vs. 4x+ peers, sub 3 only applies to distressed Co’s), 1.2x PB (vs. peer 1.5-1.7x), and can do $3-4 / share of FCF in 2014 (~5x P / FCF) with significant operating leverage given higher plant utilization. Has very visible run-way of revenue growth as it either (1) serves clients in a consolidated industry that who will very likely ramp orders or (2) operates in a duopoly that has tremendous growth opportunity. Big catalyst 2Q14 with listing in Taiwan and will prompt 50%+ rerating given higher peer multiples and better investor reception. Management still has ~$60 mm war chest to repurchase stock (can buy ~2 mm shares or 7% float). I see 50%+ upside within the next 6-12 months, and if the industry dymanics stay (CEO shoots for 1 Bn revenue in 3 years vs. ~$650 mm now in a closed-door meeting w/ investors).

-       Gross margin expansion into 2014+ due to depreciation drop-off: Overspent in CapEx 1 year before the crisis and almost went bankrupt as its once largest clients, Spansion and ProMOS, had trouble paying their payables. The company estimates the lives of its PP&E to be 1-5 years. As the large PP&E tapers off with depreciation from its $950 mm peak in 1Q08 and CapEx requirement declined significantly, the company’s depreciation cost should drop from ~$200 during peak  to sub $100 mm in 2014 and beyond (expect ~$120 mm in 2013), adding ~$0.60 / share to the EPS. The Depreciation drop-off between 12-13 already helped gross margin by at least 300 bps.

-       Potentially significant and robust revenue ramp on memories business (60% revenue): Micron had been a 10% revenue+ loyal customer of IMOS since 2007 with revenue increasing every year. It currently makes up of 14% of IMOS’s revenue. Post Micron’s Elpida acquisition, MU’s capacity jumped dramatically, and I believe IMOS will get the lion share of the order ramp, taking significant share from Elpida’s previous OSAT partner Powertech. Given (1) the industry’s transition to smaller, stacked chips that require more know-how and well-planned supply chain process, (2) MU & IMOS’s good working relationship, and (3) the highly consolidated DRAM industry, IMOS’s testing and assembly business (~60% revenue) should see a strong uplift going forward.

-       Its other line of business (LCD Driver IC + gold bumping) is a duopoly (40% revenue): IMOS has 30-40% market share and ChipBond (6147 TT) has 40-50%. This market is not big enough the for the bigger competitors, and the equipment required for testing & assembly are very different (so no cross-overs and need sizable CapEx spend). Without getting too technical, LCD driver ICs help move pixels around on the screen; as the demand for thinner screens go on, a specific design was invented to stick the LCD driver directly on the glass. But this method requires a specific technology due to temperature and material constraint, and only IMOS and ChipBond have the scale and technology to do so profitably, thus controlling the market. With more smartphones being sold (more volume), more larger screen (more LCD Driver IC and thus more volume), thinner (demand for this method +) LCD TVs being sold in China, this line of Business for IMOS should achieve significant profitability. In particular for the bumping segment (16% revenue), Chipbond has ~25%+ but IMOS’s only has 7.5% gross margin due to capacity add; there is no reason to believe why IMOS cannot get to Chipbond’s level, and this could add another $1 / share to EPS. IMOS has already pulled 2014’s CapEx forward to 2H13 due to heavy demand, we should be seeing 20%+ growth into next year.

-       Listing in Taiwan will be the catalyst to multiples rerating:-       management had been taking action towards simplifying its corporate structure and listing in Taiwan – (1) shaving its stake of ChipMOS Taiwan from 84% to 62% currently to fulfill the <70 nbsp="">one-party ownership requirement of the mainboard, (2) getting listed on Taiwan’s Emerging markets exchange in April, and just filed an official 6-K today saying that it applied for listing on TSE to be completed on 2Q14. Once complete, I expect multiple initiations of coverage locally. Semiconductor companies are much more well-known there and are typically valued @ 1.5-1.7x PB, ~15 x P/E, 4.5-6x EV/EBITDA for a healthy enterprise. Simply applying these multiples for IMOS gets us to a $30-40 / share valuation.

-       The Press release today about TSE listing: http://www.sec.gov/Archives/edgar/data/1133478/000119312513455769/0001193125-13-455769-index.htm

-       Also a tidbit, when IMOS sold 21.3% (180 mm ChipMOS Taiwan shares) stake to comply with TSE listing rules, the management took down 22 mm of it (valued roughly at $19 mm USD). Good vote of confidence.

-       Here’s the link to the tidbit: http://www.chipmos.com/_en/05_news/01_detail.aspx?MainID=15&ID=346