My Nam Tai Story
Sometimes it is easier to develop an idea in your head than it is to write about it. That is because while you can make a decision to buy a stock on an idea that makes sense, you really can’t write well about it without understanding the story.
My Nam Tai story goes back to a fellow who follows the blog and posts by the moniker DTEJD1997 on the Yahoo! Finance boards and on SeekingAlpha. While I know his real name, he asked that I only refer to him as DTEJD1997 here, so that’s what I will do. Anyways, DTEJD1997 has a nose for finding overlooked value. He was the fellow who also got me onto the idea of Rurban Financial. Obviously that idea worked out extremely well.
DTEJD1997 recommended Nam Tai to me months ago when the stock was $5 but I didn’t get in at the time and it moved from to $10. I didn’t get in because I didn’t really look closely at the story and so I didn’t understand the impact of what he told me.
I didn’t look closely because Nam Tai is a contract manufacturer in China. I worked for a contract manufacturer for a while and so I know its an ugly, low margin business. I was less than enthused to jump into that industry. It’s the old Donald Coxe adage that those who know it best love it least.
DTEJD1997 said that the rumor and scuttlebutt was that Nam Tai had a contract (indirectly) for Apple products, specifically for LCD screens, and that this could be a game changer for the company.
While it made sense to me that this should have an impact, I didn’t look far enough into the details to understand the story of why and how much. It wasn’t until the stock was much higher that I took the time to do the work. Fortunately, what I’ve found is that the stock most likely has room to go higher.
Evidence of Apple
Since the time that DTEJD1997 explained to me the idea, in addition to the stock price going up about 100%, there has been more evidence that indeed Nam Tai is a sub-supplier to Apple through Sharp and Japan Display.
In particular, the evidence suggests that Nam Tai is manufacturing LCD Modules, which are a subcomponent of the LCD panel. Apart from the rumor, which is rampant and seems to be accepted from just about everywhere I have read, the evidence I have found suggests that Nam Tai is indeed supplying to Apple. That evidence is as follows:
- Direct Suppliers: On the second quarter conference call Nam Tai stated that the company had began to manufacture modules in June for Sharp. Sharp is one of the display suppliers for the iPad. On the same conference call Japan Display was mentioned as a customer for smart phone modules. Japan Display is a supplier of the iPhone 5
- Timing: With respect to the iPhone 5, the ramp up of LCD modules coincides perfectly with the introduction of the iPhone 5. The tablet ramp up in June coincided with Sharp’s delayed delivery of tablet panels for Apple’s new iPad.
- Retina Displays: On the second quarter conference call, an analyst made specific reference to tablet retina displays being produced by Apple. Nam Tai let the comment go, and did not correct the analyst. The terminology is unique to Apple, is used to describe the screens on the new iPad’s and again, is being produced for Apple by Sharp.
- Volume: On the second quarter conference call Nam Tai provided expectations with respect to the volumes of LCD panels produced for both the tablet and smart phone customer. It was estimated that 2-4 million screens per month would be manufactured for the smart phone modules. Tablet volumes were estimated at 200,000 to 1 million per month. These are the sort of volumes one would expect from Apple products.
- Size: The smart phone modules are for a 4″ display, while the tablet modules are for a 10″ display. These are consistent with the display sizes of the Apple products.
- Secrecy: Also on the second quarter conference call, Nam Tai said that they are prohibited from releasing the end customer for both their tablet and smart phone production. While this in itself is no guarantee that Apple is the end customer, it is well known that Apple is more concerned about secrecy than its competitors.
I am willing to take the above evidence, which is admittedly circumstantial, and draw the conclusion that Nam Tai is making sub-components for Apple products. I’m not the only one. This SeekingAlpha article came right out and presumed that the products are Apple’s.
Putting some numbers to the production increases
Regardless of who the end consumer is, the volumes, margins and prices that Nam Tai has estimated from the new smart phone and tablet production are material. Below I have compiled snippets from the second quarter conference call, though it should be noted that I have been forced to fill in a few blanks from comments made on the NTE Yahoo! board, because the call is no longer available and I don’t have a detailed transcript.
Tablet LCD Modules
- 200,000 to 1 million per month
- $80 per module
- 6-8% margins
Smart Phone LCD Modules
- 2-4 million per month
- $30 per module
- Margin of 5-7%
It’s pretty simple to do the math on this and figure out revenue and gross margins. Using the midpoint of both volume and margin, for the tablets monthly revenues would be $48 million and gross margins would be about $3.36 million. For the smart phone, revenues would be $90 million and monthly gross margins would be $5.4 million. Together the two production lines would result in quarterly revenues of around $414 million and quarterly gross margins of $26 million.
While the stock has moved a lot, when I look at the aforementioned numbers I think it could go higher. Below I have created a little spreadsheet that goes back to the beginning of 2011. To extrapolate sales and costs forward, I averaged the results of the 5 quarters from Q1 2012 to Q1 2011, and than added to that the revenues and costs associated with the new smart phone and tablet revenues. I bumped up selling, general and administration costs a little to account for increases due to the extra volume, though I think that much of this has already been baked in over the past number of quarters.
I believe I am being conservative with respect to the legacy business. While I averaged revenues and margins over the past 5 quarters to come up with a going forward estimate for the legacy business, margins included the ramp up of the Wuxi factory and there were significantly lower than previous years. One of the risk factors that the company sited in the 20f form filed for 2011 was with respect to gross margins. The company provided the following graph of annual margins:
The company clarified the impact to gross margins from the ramp up at Wuxi with the following statement (my bold):
During 2011, our gross profit margin dropped from 9.6% to 4.7% as compared with 2010. In 2011, we were still burdened with launch costs for new projects in our facility in Wuxi which reduced our overall gross profit margin by 2.0%. Additional launch costs for new projects could impact our overall gross profit margin in the future. Wages and allowance increased by 48%, which reduced our overall gross profit margin by 1.6%.
There is also the potential for additional business and growth. When I was talking to DTEJD1997 about the company he mentioned that a few years ago (I believe it was 2009) the company originally announced that they were changing strategy and going after high volume LCD display work. They began construction of a factory, later adding a second, but at the time seemingly had no firm commitments from customers. In retrospect, it seems likely that they did have some commitments, and that the factories would not built on spec.
Fast forward to today.
In Shenzhen China, where they are producing the smart phones, in their 2011 20f form, the company stated that they had the following construction plans (my bold):
The first project is the development of the Company’s raw land in Guangming Hi-Tech Industrial Park, Shenzhen, PRC, approximately 30 minutes from its existing facilities in Gushu, Shenzhen and approximately one hour driving distance from Hong Kong. We acquired the land use rights to approximately 1.3 million square feet of land in 2005. We plan to develop this land into new manufacturing and support facilities to supplement our manufacturing capabilities in Shenzhen. We believe that immediate expansion of our manufacturing facilities in Shenzhen is needed because we expect that the production capacity at our principal manufacturing facility in Shenzhen to be fully utilized by the end of 2012.
In Wuxi, the company has the following plans:
Our second Wuxi phase II expansion project involves our acquisition of the land use rights to approximately 500,000 square feet of raw land adjacent to our manufacturing facility in Wuxi. On the land adjacent to our facility in Wuxi, we plan to construct buildings that will support our operations such as a manufacturing plant, a canteen, a labor activity center, a research laboratory and testing and training centers. The land was split into 2 portions for acquisition as required by the Government.
In the risk-factors, the company sighted the risk if the Wuxi factory is not completed (again my bold):
Similarly, we expect that our existing Wuxi facilities will reach full capacity by 2013. In order to increase capacity and house additional workers at our Wuxi facilities, we believe we need to complete construction of the planned adjunct facilities by 2013.
I think its a reasonable assumption to think that these factories are also not being built on spec.
There could also be growth from the existing products. iPad sales in the last quarter were estimated at 17 million. iPad sales for the 3rd quarter are expected to be anywhere from 15-16 million units to some bullish forecast predicting as many as 20 million unit per quarter. Meanwhile, iPhone 5 production is pegged at 5 million in the quarter ending September (with September being the first month of production) followed by 22 million in the 4th quarter.
My point here is not to predict the future growth of Apple products. It is only to illustrate the size of the iPad and iPhone market in comparison to the estimates made by Nam Tai (which was for 200,000 to 1 million units per month for tablets and 2-4 million per month for smart phones).
Growth could also come from future products. One interesting item that will make listening to the November 5th conference call extra interesting is the recent announcement of the iPad mini. Apple is expected to release a smaller iPad at some point in October. Supplier have apparently begun to ramp up production of the parts for this device. While Nam Tai will not come out and say anything specific on the next conference call, there may be important hints as to whether the company is taking part as a supplier of iPad Mini components.
This isn’t a reverse takeover
The last thing I want to say is that Nam Tai didn’t come out of a reverse merger. There have been so many Chinese companies that have been “outed” over the last couple of years that Chinese company has become a dirty word. Almost all of these companies that turned out to be fraudulent became listed on the American stock exchanges by way of a reverse merger. A reverse merger allowed these companies to become listed without having to file registration statements, which likely would have detected the fraud.
Nam Tai has been around since 1975. They have been paying a decent dividend since at least 1991 (the last available report I can find access to). The company is a supplier to a number of large companies, including Toshiba, Sony and Sharp. There is no evidence that I have been able to find that the company has any of the sorts of problems that some of these other Chinese companies have. Finally, in my opinion no one in their right mind would decide that the place to set up a scheme is in the low margin, dog eat dog business of contract manufacturing. You’d have to be crazy. Nevertheless, I have little doubt that they have been painted by some with the same brush, and that this may contribute to why story hasn’t caught on with some.
I don’t think the stock has fully priced in the earnings that were guided to a few months ago. I know the stock hasn’t priced in any of the upside from increases to that guidance, expansions, the development of additional products, or the recognition by the wider investment community that this is indeed an Apple supplier. We’ll see if some of those possibilities begin to materialize over the next couple of months. My bet is that they do. Looking ahead, there probably isn’t going to be much news reported other than rumor until the conference call on November 5th. I’ll be looking forward to that date.
Let’s go with 37 cents per quarter annualized to around $1.5. You believe an appropriate multiple for that level of earnings is what? We are already trading at a 7 multiple to those. If you look at the big boys in this business like Flex, Jabil, etc they tend to trade on up to 9x historical earnings and maybe 6.5 to 7x forward earnings.
There is a significant quality of earnings problem in valuing NTE. A Jabil or Flex might have six key customers and literally 20 main products that drive revenues. So you spread risk out widely and no one customer or project breaks you.
NTE is already trading at a similar multiple to forward earnings as a Jabil or Flex, but NTE has all of its eggs in one basket. And we already know how this story ends. Ultimately someone else will grab that business and limit their growth, and at that point their earnings implode and the stock loses all its value in a few days.
Maybe this goes to $30 as it did years ago. But that all looks like speculative frenzy, and you have to sell that all the way up mercilessly.
So I just want to clarify that no one said here they think the stock is going to $30. I’m not sure where you got that. I don’t think I put a projection on the stock, but if I was going to, I would say that I think its possible it runs over $15 in the next 6 months. That would be my goal here. And there is a chance it goes higher (maybe $20) if orders turn out to be much higher for some reason. That’s the upside.
I did forget to mention the cash on hand, which isn’t insignificant at over $3 per share.
I think what happens going forward boils down to whether something goes right or wrong in the next few months. While you are right that something could go wrong and Sharp and Japan Display could pull their orders or volumes could turn out to be lower than anticipated, given the direction of things of late it seems more likely to me that something goes right. Possible things that could go right include indications that they are making LCD modules for the iPad mini, or revenue comes in higher than was guided to last quarter, or the ramp up going forward turns out to be stronger than anticipated. I just see a lot of potential good news coming out in the next couple months. I think that’s the bet here.
But your point is well taken and I said it myself. Its a tough business. The business in general deserves the multiple it gets. There is a chance that volumes don’t last. NTE will need to continue to get Apple business to prosper going forward and that’s an open question. It certainly is not without risk.
NTE has many different customers, but the Apple work is certainly their largest. NTE probably will have at least $500MM in other revenue from Nintendo, Sony, Sharp, Texas Instruements, etc. Apple work is going to be the main source of revenue going forward, but not the ONLY source.
As to the other companies…their balance sheets are a MESS compared to NTE’s. Currently NTE has about $3.50/share with virtually no debt. FLEX has a NET DEBT position of about $1BB. JABIL is in relatively better position, but it still has a net debt position of a bit over $400MM.
In stark contrast to JBL & FLEX, NTE has a long history of paying dividends. FLEX pays no dividend, JBL has a very low yield. You can be sure NTE will raise the dividend when they are making more money.
I would argue that JBL & FLEX have traded up to 11x or 12x earnings.
If we assume NTE will be earning $1.50 or so…put a 10X P/E on it, you come to $15. Add back the cash, which by that point could be AT LEAST $5/share, you could come to $20/share.
That is a fairly conservative valuation.
There is speculation that NTE could earn MORE than $1.50/share. maybe, maybe not. The potential is CERTAINLY there.
I would also argue that Apple work is MUCH more valuable than just about any other type of work.
If NTE can perform well, there is a very high chance that they will receive MORE work. Apple has a vested interest to start spreading work amongst different contractors. Apple has a problem with too much concentration in Samsung & FoxConn.
As 2003, NTE tripled in under a year. They had strong earnings and good results, the economy was also strong. HOWEVER, I suspect NTE will be ramping up sales and earnings at an even fast rate this go around. Also, NTE did not have any “halo” effect from Apple work back in 2003.
We are starting to see some “excitement” from Apple work already. Trading volume in NTE has started to build substantially. What happens if the “fast money” or “Jimbo Crammer” crowd gets into NTE?
NTE is somewhat of a speculation, but I also think it has potential to move MUCH higher yet.
We’ll know a lot more 11.5.12
NTE quarterly earnings without Apple: circa 5 cents.
NTE quarterly earnings with Apple: circa 37 cents
That’s what I mean by having all your eggs in one basket. No NTE won’t go out of business without Apple. NTE will lose 60% of its valuation in two days without Apple, cushioned primarily by its cash.
Personally, I see this opportunity as gambling not investing. I’m not above speculation at all, and it’s all about price and risk and reward.
After writing my response I had a nightmare last night!
I dreamt a VERY odd dream…
I dreamt it was a little more than a year in the future, and I was wondering where I went so wrong.
Specifically, NTE was disclosed to be working for Apple. In fact, they even got a bit more business from Apple, another “small” contract. NTE was also getting their legacy business into shape. They were earning a bit over $2/share, AND THE STOCK WAS DOWN. It was trading for about $10/share!
For in my nightmare, NTE did just about everything right. They earned money, had money, and were going to make money in the future. THE STREET JUST DID NOT CARE!
This has happened before. NTE traded significantly UNDER their cash holdings for several months back in 2008/2009. NTE bottomed out just a hare above $3/share. At that point, they had almost $6/share in cash+inventory+buildings+long term land leases….
Never in my life would I have thought a company that had financial stats like NTE did/has would trade at a significant discount to cash! Of course, NTE was not the only case…Nothing like that had happened since the Great Depression.
So I guess you are right, everything is a speculation to one degree or another.
As LSigurd can personally attest to, I’ve made some very good calls in the past. Perhaps I have an inordinate amount of luck.
Again, it’s about quality of earnings. To get to a share price of $20, earnings have to be 85% attributable to a single customer. That makes the $1.5 in projected earnings very low quality, in my opinion. The company is subject to a massive price share correction in a flash.
Realistically, there are no barriers to entry for these earnings. They got lucky, will ride the Apple bull for a while, and eventually they will be thrown off. Given the bloody competitiveness of the contract manufacturing industry, that is a certainty. Will it be six months or four years? Roll the dice.
Having said that, were I to establish a position in a speculation like this, I would be taking profits rapidly all the way to $20 share price.
I didn’t say I wouldn’t invest in this. I would want a lower price however.
I’m not criticizing your luck or your call. I am characterizing the level of risk.
Obviously customer concentration is an issue, but it’s a strange risk to overweight when they’ve produced ONE month of tablet revenues, zero of smartphones. The apple business is incremental to every dollar of revenue they’ve booked in “other” and operating margins have been under pressure from start-up costs/shift to LCDM high volumes. You’re being too punitive (without that shift to Apple, which took longer than expected, their performance last few years would have looked different).
I feel your point on the boom bust nature of this, but the boom is longer than two quarters my friend. Who invests that much capital to dedicated production lines without a little reassurance?
OK, maybe we are going to have some amount of good luck here.
NTE was up well over $1/share and had good volume.
The critical day, Monday’s earnings are coming up soon.
We will know a lot more then.
As to the length of their contract, I think it could be for a VERY long time. How long has FoxConn been a manufacturer for Apple? Almost as long as I can remember. Certainly 10+ years. If NTE can do a reasonable job on quality & price, how long will they be a supplier to Apple? I’m going to guess that could be DECADES instead of years or months.
Additionally, as NTE and Apple solidify their working relationship, there could be a lot more work for NTE. NTE has long established relationships with Sony, Nintendo, and Texas Instruments that span decades. I don’t see why Apple would be any different.
Of course, I could be wrong. We’ll see Monday.
Ok, ok, ok….
I have to admit I was wrong in my projections and estimations.
It appears that I was much too low in my assessment of earnings potential and sales potential.
I was also completely wrong about the dividend. I was thinking the dividend MIGHT go to $.10/share. It went to $.15/share.
Earnings were $.54/share for the quarter. I was hoping for the mid 30’s.
REMEMBER, this was a weak quarter. They now have 1 quarter’s FULL production of “tablet” panels. HOWEVER, they have LESS than a full quarter’s production on smartphone panels.
Next quarter should be better than this one, as they will have full production of phone panels.
On the conference call this AM, Mr. Koo stated that production capacity of phone panels is about 4MM per month. In practice, they should be at about 85% to 90% of capacity.
What is so very interesting is that they are shutting down production of low margin B&W panel production at this factory in March 13. Mr, Koo was asked if production of phone panels can be increased when this line is shut down. He said that workers will need to be retrained as skills are different for the different products. He also stated that most of the machinery can NOT be used, as the phone panels are a totally different technology. When this line is shut down, NTE can almost double production capacity of phone panels. So WUXI will have capcity of 8MM panels per month in 2013.
Another interesting tidbit is that the factory in Shenzen is now sitting on land that is being rezoned as high end commercial. NTE will have to move the factory to a new plot of land. NTE will own the land under the old factory, and it will developed into something else. This is going to be a VERY valuable plot of land. In the past, Mr. Koo has proved himself to be a very astute real estate investor in both Hong Kong & Macau. NTE made a LOT of money in the past off of real estate sales. Looks like that will happen again.
Another interesting tidbit is that the “unnamed customer” has invited NTE to bid on a 3rd product. Who knows what that could be? I am going to guess that is the iPad mini.
Overall, very interesting developments today.