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Adding Silicom after the Collapse

What a terrible piece of news.

Silicom ran up to almost $80 on expectations of a major cloud player using their 100G switch fabric NIC card in their next-gen cloud architecture.  The run rate on the contract was supposed to exceed $75 million in 2019.

Silicom had about $125 million of revenue in 2017 so clearly the deal was a game-changer.  When the company announced last week that the customer was pulling the pin on the product, the stock tumbled.

It actually tumbled for some time before the announcement, which is pretty sketchy.  Clearly someone knew something.

Others might steer clear of a stock that behaved like that.  But I’m willing to take a chance.

I found it hard to come up with what the numbers will look like without the cloud deal because Silicom has been tight-lipped about it on the calls.  Needham seems to think that Silicom has recognized $30 million of revenue from the cloud customer so far, though I’m not sure if they are including the first quarter in that estimate.

My best guess is that the run rate ex-cloud deal is around $100 million.  The stock has about a $240 million enterprise value at the current level.  So its at 2.5x revenue.  Maybe trading at a 10x EBITDA multiple, maybe a little less?

I’m okay with those multiples because there’s still is a lot of room for growth.  The company put out a press release later in the week where they outlined that they were “close to several major, strategic new SD-WAN and NFV-related vCPE Design Wins from major telcos”.  They expected the first to materialize in the “near term. ”

They said that each potential win would ramp to $10 million plus revenue run rate.

In the same press release they announced a dividend cut, saying they would need cash to ramp these customers.

A cynical take is that the press release was manufactured to justify the dividend cut.  After all it’s possible that Silicom had already procured inventory from the cloud player and will now have to write it down.

That’s a possible scenario, but I’m not convinced its the right one.  For one, inventories were only $7 million higher at year end than the previous year and were actually down sequentially in the fourth quarter.   This with revenue that has ramped from $25 million a quarter to $30 million plus over the last year. There’s not a lot of evidence of an unusual inventory ramp.

Second, they have $35 million of cash on hand at the end of the year.   So you’d need a big write-down to deplete that.

Third, to think Silicom ramped inventory in the last two months on a product that they described in February as having “no general availability to customers” and that was still experiencing a “customer challenge” that kept the design from being finalized, doesn’t make a lot of sense to me.

There could be a write-down coming, but I doubt it’s too much.

My guess is it’s exactly what Silicom said in their press release: that these are big potential wins and that Silicom “must make sure that we have all the financial resources to fulfill demanding supply commitments once these potential wins reach their full deployment run rate”.

These are potential telco wins after all.  I know from my experience with Radcom just how important cash levels are to telcos looking to make large purchase orders with small suppliers.

If anything I suspect that Silicom was planning a secondary on the announcement of their first big telco win.  But the cancellation of the cloud deal and collapse of the share price makes that far less desirable.  So they are saving money where they can.

If that’s the case, then I think that when such a win is announced, the stock will move back into the $40’s.   At the current price I’m willing to take the plunge and see if that’s the case.

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