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Hortonworks Fourth Quarter Update – The hadoop adoption cycle continues

Hortonworks is the second of the three companies I own that reported on Thursday night.  The first, Ichor Holdings, I wrote about yesterday.   The third, Radisys, I’ll get to shortly.

I originally wrote about Hortonworks along with another company Attunity in November after doing some research on Hadoop and concluding that its adoption presented a good growth opportunity for the companies involved.  At the time the stock was trading at $6, had recently been issued a sell recommendation from Goldman Sachs, and was pretty hated all around.

Nevertheless the company was growing like a weed (40% annually).  It was also bleeding cash flow like a sieve.  But at an enterprise value of less than 2x revenue I found it difficult to pass up the growth.  Knowing Wall Street loves those growth stories, I figured a couple solid quarters would put the stock quickly back on its feet.

Fast forward a few months and that is exactly what you got.  The company is still growing like a weed (revenue was up 39% in the fourth quarter, guidance was for 28% year-over-year growth in 2017), they are not bleeding cash flow quite so materially (cash flow in the fourth quarter was actually close to flat), and the stock isn’t hated quite so much.

At $11 and with a $1.40 of cash the stock is still trading at 2.4x revenue.  So the valuation is actually not that different than when I bought it.  One key difference is that back then the cash level was higher (roughly $130 million), the shares outstanding were lower (the company issues stock like toilet paper) and the price per share was lower, so cash was a much bigger piece of the overall valuation and that was partly what I found interesting.

The most interesting thing about the fourth quarter was that growth in their Hortonworks Data Flow platform has really taken off.  I wrote about HDF in my original write-up.  I’ll repeat how the company described HDF at the Pacific Crest conference last year:

Now [customers] want to have the ability to manage their data through the entire life cycle.  From the point of origination, while its in motion, until it comes to rest and they want to be able to drive that entire life cycle.  It fundamentally changes how they architect their data strategy going forward and the kind of applications and engagements they can have with their customers.   As they’ve realized this in the last year its changed everything about their thinking about how they are driving their data architecture going forward starting with bringing the data under management for data in motion, landing it for data at rest and consolidating all the other transactional data.  So it’s a very big mind shift that’s happening.

I still think HDF could be a big growth driver for the company and we are starting to see that.  They said on the fourth quarter conference call that HDF grew 6x year over year in the fourth quarter.

So there is lots of reason to think growth will continue.  Nevertheless, I am reluctant to add.  It’s the cash flow that still gives me pause.   While the fourth quarter number was good, they’ve approached break even cash flow in the past only to diverge again into big losses the following quarter.   They said on the call that they expect mid-teens negative operating cash flow in the first quarter.

More optimistically, they also said that they expect break-even cash flow in the third or fourth quarter.  So that would be a turning point.  But then in response to a question about whether we should expect free cash flow after that, if felt like they were trying to scale back expectations:

Yes, I don’t want to talk beyond that yet, Q3, Q4 seems a long way out, but from a – if you think about free cash flow we have been running may be $2 million to $3 million a quarter on CapEx. Q4 was a little light, I think it was under $2 million, but I think once we get to the sort of breakeven number sometime between Q3 and Q4 we will reassess to how much above that we want to punch.

So I’m not sure what to think.

Hortonworks also issues a lot of stock, which while it doesn’t factor into the cash flow number, does dilute shareholder value.  The shares outstanding have gone up by almost 3 million in the last couple of quarters.

On the other hand is my experience with Apigee.  Another high growth company, with cash flow, that was issuing lots of shares, and the company never really sorted any of that out yet the stock tripled from the $6 price I bought it at to the almost $18 where it was bought out by Google.  Hortonworks could easily follow that path.

There are certainly reasons to add.  Strong growth, ramping of HDF.  They announced another new product launch, enterprise data warehouse in February, and are gaining traction on their Azure and AWS offerings.  They also stand to gain visually from accounting changes enacting in 2018 that will allow them to defer less revenue and spread out commission expense, in turn improving the income statement.

Nevertheless my gut, informed by the aforementioned concerns about cash generation and stock issuance, is telling me not right now.

I think if the stock pulled back on a market pullback I would be more likely to add.  But it’s hard for me to double up at this price, as I have been prone to do with other ideas that start to work.

So I’ll probably sit with my 2-3% position and watch what the stock does.  I prefer to take the safe route when my gut is giving me pause.

Fourth Quarter Update: Ichor Holdings beats and beats

I have a lengthy update on Oclaro that I finished a couple of days ago and was planning to post this weekend but it will have to wait a few more days because I wanted to write a few short posts about what was a busy day on Friday.  After going a few days without any significant earnings updates, I was blitzed on Thursday night with 3 sets of year end results: from Radisys, Ichor and Hortonworks.

Two of these companies, Ichor and Hortonworks, produced unquestionably solid reports.  The third, Radisys, was considered a disappointment by analysts.  Of the three names, I added to my position in one, and it wasn’t the one with positive results.

I’ll start with the beats in this post by talking about Ichor.

Ichor Holdings

I wrote up the reasons for taking a position in Ichor about a month ago.

This was the first quarter that Ichor reported as a public company.   The report was very good, and the guidance for the first quarter was excellent, but all of this was expected.  Ichor pre-announced both in early January.

The most interesting new tidbit came from the conference call, where in response to a question asking ‘what if things get even better?’, management described their recent capacity additions.  They said that they had recently added or were adding enough capacity to support $200 million of quarterly revenue.  This is quite a large number.  Consider that with the “big beat” in the fourth quarter the company had $131 million of revenue, and that they are guiding to $150 million in the first quarter.  Only a year ago Ichor was generating a little over $60 million a quarter.

As strong as business has been, this has to be considered an indication that management sees it getting even stronger.

Given the growth (over 104% year over year and 24% sequentially in the fourth quarter), the concern of many, myself included , is that at some point this turns.  These capacity adds, which presumably are being done now because of some visibility of what is to come, allay those concerns in the near term.

The company supplies its gas and liquid delivery systems to two major customers, Lam Research and Applied Materials.  These two customers make up 90% of its revenue.  Both of these companies have projected a slower second half.  But even that level, which was described as a 55/45 H1/H2 breakdown on the call, is significantly higher revenue than Ichor was generating a year ago.

The company trades at a reasonable multiple considering the growth that is occurring.  If you annualized the fourth quarter results, the stock price is at 7x EBITDA.  The multiple shrinks to even less than that as revenue ramps higher in the first quarter.

Yet I struggled to add to my position on Friday even as the response to the report was somewhat muted.  I worry about being blindsided when the turn comes, as I feel like I have very little insight into the catalysts that will precipitate it.

It could happen in second quarter or in two years, I just don’t know.  The company suggests it may be more prolonged than many expect, as the drivers, which are 3-D NAND and multi-layer designs, are becoming ever more prevalent, and in the gas delivery business they have room to take market share from smaller competitors.  They are putting their money on that by investing in more capacity today.  But I wonder if Ichor is so far down the food chain that when the inflection comes they will be one of the last to know.

Thus I suspect that Ichor is destined to remain a 3-4% position for me, which I hope through appreciation eventually becomes a 5-6% position, but which I find unlikely I will be inclined to accumulate further and make it a portfolio changing score.

Community Bank Earnings: SFBC, SBFG, PKBK

 

Owning community bank stocks is boring.  Even on earnings day they often trade less than 1,000 shares.  The shares move up and down on so little volume that you never really believe the moves are real.  They seem like dead money, but then a year passes and you check out your account and you own a bunch of stocks up 20% and you can’t figure out how that happened.

So get ready for a boring but quite possibly profitable update.

I’ve had a number of the community banks I own report fourth quarter results.  All of the results were good so far.  I’m going to go through 3 of them here.

SB Financial (SBFG)

SB Financial was the first to report, a couple weeks ago.  The company made 37 cents EPS in the fourth quarter and $1.37 for the year.  The stock has traded up since the report, but even at $17.50 the PE multiple remains low at 12.5x 2016 earnings.

sbfg_eps

One of my criteria for buying a bank was loan growth and deposit growth.  These are the two pillars that will lea to eventual earnings growth (as long as the bank is well run and can leverage their expenses).  Loan growth at SB Financial continued in the fourth quarter, up another $15 million or 14% year over year. Deposit growth was up $20 million or 15% year over year.

sbfg_loansanddeposits

My one complaint was that earnings were somewhat low “quality” compared to the past few quarters.  Fee income was a little lower ($1.5 million versus $1.6 million in the second quarter), while the company got a big gain from the mark to market of its mortgage servicing right portfolio.   I’ve talked about mortgage servicing rights in the past. The mark to market adjustments from servicing rights can be large as they are very sensitive to changes in interest rates.  But this doesn’t really reflect health of the underlying banking business and if anything it portends to lower originations.

Nevertheless return on equity (ROE) was 10.72% and return on assets was 1.14% which are solid numbers.  Non-performing assets remain a small percentage (0.65%) of total assets.  I am happy with the results.

Sound Financial (SFBC)

Sound Financial put together a similarly good quarter.  Loan growth was 8.4% year over year.  Yield on loans reached 5.19%, which is a 10 basis point bump in the last year.  Deposit growth was 6.3% year over year.  Non-interest bearing deposits, which are the best because they are essentially free, rose to 13.6% of total deposits from 11.5% of deposits the previous year.

sbfg_loansanddeposits

Deposits should continue to increase in the first quarter after the pending purchase of deposits from Sunwest bank in October:

Sunwest Bank of Irvine, California to acquire approximately $17.7 million of deposits for a core deposit premium of 3.35% and its University Place, Washington branch located at 4922 Bridgeport Way West.  The cost of funds from this branch is an attractive 17 basis points and the cash received is expected to be used to pay down FHLB borrowings.

Earnings per share were 63 cents in the fourth quarter and $2.16 for the year.  On a trailing basis the stock trades at 13.4x earnings.


sfbc_eps

Like SB Financial, Sound Financial suffered from lower fee income which declined from $647,000 to $586,000. I’m not sure the cause of these declines and whether there is general pressure on the industry.  It is something to keep an eye on.  Also like SB Financial, they took a gain on mortgage servicing rights, though the servicing portfolio is much smaller so it was to a much smaller degree.

Book value rose 80c in the quarter and is now $24.  Return on assets crept up to almost 1%, at 0.97% up from 0.89% at the end of last year.  Return on equity was at 9.4%.

Non-performing assets are up a little, to $4.5 million from $2.9 million a year ago, but this is still a tiny 0.77% of assets so nothing to worry about.  Again, solid performance and it remains a cheap stock.

Parke Bancorp (PKBK)

This is going to feel repetitive.  Parke Bancorp had a good quarter as well.  They saw year over year loan growth (15%) and deposit growth (18.6%).

pkbk_loansanddeposits

Diluted earnings per share for the quarter were 38c.  For the year, earnings per share were inflated because in the second quarter the company sold its small business admin loan business for a $9 million gain.  Excluding that sale I estimate diluted earnings for the year would have been about $1.50.  That trades the stock at 13x earnings.  Below is diluted earnings ignoring the sales of the SBA business.

pkbk_eps

Earnings likely would have continued to grow in the third and fourth quarter had the company not chosen to monetize their SBC business.  I’m not sure why the bank sold it?  In the second quarter press release they referred to it as a “unique opportunity”.  It’s possible they just got a great offer, which the profit (over $1/share) suggests.  They still plan to offer SBA loans through their bank, but it probably won’t be at the same scale.  There were no SBA loans sold in the third quarter and no the fourth quarter press release there was no mention of SBA loans sold.

Parke Bancorp has somewhat higher non-performing assets than the other banks I own, at $21.7 million or 2.4% of total assets.  Over half of that amount is real estate owned.  In the fourth quarter press release the bank mentioned one property in New Jersey that has been written down from $12 million to a little over $3 million.  The trend on non-performing assets is in the right direction though, they stood at $30 million a year ago.

The bank has opened two branches in the last year, which is helping deposit and loan growth.  The first is in Collingswood New Jersey and the second is in Chinatown Pennsylvania.   These banks are still ramping and should help fuel growth in 2017.

Combimatrix: Just too cheap

I stumbled on Combimatrix shortly after taking a position in Nuvectra.  The companies have similarities.  Both are very small biotechs trying to gain momentum on sales.  Both have showed recent growth.  And both have a large part of their market capitalization tied up in cash.

But Combimatrix is cheaper.  To be honest, I don’t quite understand why Combimatrix is as cheap as it is.  It’s possible that there is an element to the story I a missing.  When I bought the stock, in the low $3’s, the market capitalization was a little over $8 million.  It’s closer to $10 million now.  The company has over $4 million in cash and very little debt.

While there are many biotechs around that boast high cash percentages (Verastem, for example, remains with a cash level well over 2x their market capitalization) these companies aren’t generating any revenue.  Combimatrix has a revenue generating business, and the business is growing.

Combimatrix provides reproductive diagnostics testing.  They offer three types of tests: microarray, karyotyping and fluorescent in situ hybridisation (FISH).  I believe these are the only three commonly used testing methods for such diagnostics.

Of the three, Combimatrix’s primary focus is on microarray testing.   It makes up about 70% of their testing volumes.  Microarray is (I think) the newest test method (based on what I’ve read, though there is some indications that FISH being applied to some reproductive diagnostics is new).  It seems that microarray tests have the advantage over karyotyping and FISH in that they provide more information about potential problems (from this article):

chromosomal microarray, detected more irregularities that could result in genetic diseases — such as missing or repeated sections of genetic code — than did karyotyping, which is the current standard method of prenatal testing.

But it is also a more expensive test.  Which has led to problems getting insurance coverage:

The tests can cost $1,500 to $3,000 in addition to the cost for the amniocentesis or C.V.S. procedure. Karyotyping can cost $250 to $1,500. Insurance does not always pay for microarray testing since it is not considered the standard of care for prenatal testing.

Looking back I believe that this is where some of Combimatrix’s problems have come from.  Insurers have been slow to adopt microarray tests into their coverage.  The company hasn’t ramped revenue they way they had anticipated.  There have been cash issues, and capital raises.  But this seems to be changing.  In August Combimatrix put out a press release with the following comment:

“There are now at least 20 health insurance providers this year that have revised their medical policies to include coverage for recurrent pregnancy loss testing,” said Mark McDonough, President and Chief Executive Officer of CombiMatrix.

Below are charts showing volume growth for the 5 segments that Combimatrix reports.  Growth is lumpy, but overall there has been a trend towards increasing tests.  They also seem to have pricing leverage, as similar charts showing revenue by product line (not shown) trend more clearly left to right.

volumes

Management has reiterated on a few occasions (most recently in the third quarter conference call) that they will be cash flow breakeven by the end of next year.  This seems reasonable as adjusted EBITDA has been trending towards that level for 2 years now.

adjusted_ebitda

So it’s a cheap stock with a business that is pointed in the right direction.   The only reason I can think of for the stock being so cheap is the risk of further dilution.  As they approach the breakeven mark this concern diminishes and hopefully the stock price responds.  At least that is my expectation.  We will see.

Week 290: Renewal

Portfolio Performance

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Top 10 Holdings

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See the end of the post for my full portfolio breakdown and the last four weeks of trades

Thoughts and Review

I came into the new year wanting to reduce my exposure.  I had racked up gains last year that I had held onto for tax gain reasons.  It’s also been a good run, and there are at least a few signs that the market is topping out.

I also find too much exposure leads to poor decisions.  The lack of cash causes me to ignore ideas I might otherwise pursue and I start to feel stuck with the positions I have.  I end up “hoping”.

When it comes to investing “hope” is a dreaded word for me.  Hoping that a takeover happens.  Hoping that a news release comes out.  Hoping that this quarter is different.

Moreover, hope is inextricably tied to patience and patience, while not so toxic as hope, has a love/hate relationship with me.  Patience is necessary.  You have to wait to have your ideas play out.  And I do this.  I sat on Willdan for 3 years before it decided to more than triple in 6 months. You can’t cash out on the first gain or jump ship on the first sign of loss.

But too much patience, at least for my style of investing, is counterproductive.  It wastes capital of all kinds.  When I am too patient with my positions it also means I am not looking for new and better ideas.

So every so often, maybe once or twice a year.  I take a hard look at every position and ask myself if I really want to own it?  Do I really believe in this idea?  And I force myself to sell at least some of them.

I have to go through a renewal.  I sell off a bunch of positions, reduce a bunch of others, and, at least in terms of my own mindset, I start over.

I did my last big reset last January and that one was sparked by the market moves.  It was not pleasant.  This reset was more minor.  I shook things up enough that I could refresh my perspective.  It seems to be working so far.

Changes to the Portfolio

I sold a number of energy positions: Jones Energy, Resolute Energy, Gastar, Granite Oil and Key Energy Services.  I didn’t time these sales particularly well, as many of these names have rallied further after I sold.

You might ask why I sold Key Energy Services so soon after buying them?   Partly it was logistics; in the account I track with the practice portfolio I wanted to raise cash and so I had to look for names to sell.

Second, it had appreciated 20% from my original price and, in light of my first reason, seemed like an easy gain.  Energy services is a tough business and so this isn’t a stock I wanted to hold for a long run.  Nothing has changed with the company though, and in my actual account I still hold my warrants, which give me exposure to upside in the stock.

I also sold Contura Energy.  I did more research on the met and thermal coal market and I concluded it was more likely that coal prices would decline than increase.  In particular, much of the increase seemed to be because of closures in China that could just as easily be reopened and there was evidence that was already happening.  I’ve been in and out of the coal market since 2006, I know how volatile it can be (especially met) and I also have experienced that when the coal price is declining it doesn’t necessarily matter how cheap the company appears, the stocks will follow the price of the commodity.  Maybe that won’t happen in this case, maybe Contura is “cheap enough”.  But I couldn’t ignore the precedents I had seen.

Even with these changes I still don’t have enough cash in the practice portfolio.  I’m running about 20% cash in my regular portfolio and am a little less than flat with the online account.

As for my remaining positions…

I still have reasonably big positions in Radcom and Radisys, but along with many other stocks I reduced these positions as well.  I am balancing my expectation that the first and second quarter results from each of these names will likely be modest with the awareness that positive news in terms of new contracts could happen at any time will send each stock much higher.  However I did decide to add a little Radcom back on Monday, which is not reflected in the update.

I also reduced Willdan.  Its just gone up so much.  I took some off at $27 and $29, which turned out to be a little early as the stock briefly hit $31.  I don’t plan to sell any more; I still really like where the company operates (energy efficiency), they should see some benefit from infrastructure plans, have the ability to pull together cheap accretive acquisitions and will also benefit from changes to the tax code (their tax rate has typically been above 40%).

Finally I reduced my positions in Attunity, Hudson Technologies and Nimble Storage.  I’m not completely confident that the results for these companies in the next quarter are going to be stellar.  I prefer to wait to see the results an add back depending on the reports.

And a few new positions…

I took five new positions in the last month.  I wrote up two of them, Ichor Holdings and Nuvectra.

I tweeted that I took a position in Vaalco Energy (hat tip to @teamonfuego)

And I tweeted that I took a position in Combimatrix:

I have a write-up in the works about Combimatrix and have plans for one on Vaalco after that.

The last position that I took was in Gigamon.  I have written in the past that I been waiting for this stock to correct and continually regretted not buying it when it was lower.   The company announced poor numbers for the fourth quarter and the stock took a massive beating.  I was happy to step in.  The stock could go lower but I am not convinced that their announced portends a trend so I wanted to get at least started with a position here.  If the stock dipped into the $20’s, I would double down.

Last Thought

I’m very edgy about Trump and his economic agenda.   Given the role that Steve Bannon has taken on, its worthwhile to read and listen to what he has said.  I might do a more detailed write-up on this in the future, but for now consider this speech.    Bannon’s ideas remind me of what you hear from gold bugs and all those economic podcasts that portend the financial end of the world.    He talks about the contingent liabilities, the trade deficit with China, its all those things you hear from the newsletter writer/economic podcast cohort.  Some of what he is saying has merit, but if he is going to attack what he sees wrong I don’t know if this plays out well.

Portfolio Composition

Click here for the last four weeks of trades.

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Nuvectra: New position, didn’t even know it was a spin-off

I don’t go out of my way looking for spin-offs.  I read Joel Greenblatt’s book You Can Be a Stock Market Genius years ago, I even did a take-off on the title a few years back, so I understand the value that can be there, but it has seemed like a saturated niche since value investing has gone mainstream.

Maybe the best way to find a spin-off is to unwittingly stumble upon one.  That’s what happened to me with Nuvectra.  I came up with the idea from a retweeted tweet by @ValuewithaCatalyst pointing to their large cash position and $0 enterprise value.

I looked into the company and found that Nuvectra is indeed trading at cash but that they also are burning through it.  The company is in the early stages of a ramp of a new neuro-stimulation therapy, called the Algovita SCS system.  They’ve hired a salesforce (headcount of 42 at the end of the third quarter and expected to reach 50 by year end) to begin marketing the product across the United States.  They have kept up a decent sized R&D program (run rate of $3.5 million per quarter) and they are only just starting to generate revenues.

The consequence is they have a fairly significant cash drain of $5-$6 million per quarter.  This plays against a market capitalization of around $60 million and an enterprise value that, up until Friday, was close to zero (I’m using the numbers based on my purchase price below because I started this post before the stock moved the last couple of days):

ev

Their Algovita SCS system reduces back pain by stimulating the spinal column with small pulses of electricity.  These pulses stimulate the nerves and override the pain sensation, replacing it with a tingling that eventually disappears entirely.

The system consists of a pulse generator, leads that are surgically inserted into the spinal column, and programmable GUI devices for the patient and physician.

algovita

There is a good video that describes the procedure in general here.

Algovita was approved in late 2015 and began to launch in the US in 2016.  So its early in the ramp.  Because Algovita is in the early stages, the market is not giving much credit to the product yet.  There is also a lot of competition.  The incumbent products are made by Boston Scientific, Medtronics and St. Jude, and a more recent newcomer is Nevro.  From what I have read, Algovita’s feature set stacks up well against the incumbents but Nevro has a very good product that may or may not be superior to Algovita.  Without question this is a very competitive landscape and that is at least partially responsible for the low enterprise value.

At this price, I think its worth seeing how the sales ramp plays out.  The company said late last year at the Piper Jaffrey conference that within 12-24 months of the beginning of a sales ramp they expect a sales territories to generate $1-$1.5 million.  This works out to 75 trials resulting in 50 permanent implants at $20,000-$25,000 a pop.  Thus the expectation from the current hirings should be at least $50 million in annual revenue.  The vast majority of their reps were hired in the third quarter and after, so we should start to see their benefit in the upcoming quarters.

The total addressable market (TAM) is fairly big, so reaching $50 million is only taking a sliver of market share away from their competitors (note that SCS stands for spinal cord stimulation):

scsmarket

Algovita revenue was $1.1 million in the third quarter.  This was up from $569,000 in the second quarter.  The third quarter was the first real quarter with any sales traction in the United States.  The company is still mostly in the trial stage with its early adopters.  At one of the conferences management said that trial revenues were only a fraction of permanent implants.

There are likely to be bumps in the road.  In addition to the newly trained salesforce, Nuvectra is making slow progress to get insurers on-board and work through hospital approvals.  The process entails agreements on doing business, payment terms, etc.  It takes time.  In smaller settings this happens in 1-3 months, while in larger regional systems it can take 3 months to a year.

In addition to Algovita the company has a strategic development agreement with Aleva Therapeutics that allows Aleva to market Algovita for use in the direct brain stemp (DBS) market for the treatment of Parkinson’s disease.

aleva

DBS is $600 million market today, dominated by Medtronic, Boston Scientific also in market.  Nuvectra will receive $6 million in aggregate payment, and recognized $1.1 million in the third quarter related to this.  Once in production Nuvectra will receive a royalty, though I actually wasn’t able to find the details on the royalty payment yet.

Finally, Nuvectra has a “world class group of neuroscientists” that they refer to as Neuronexus (interesting website here).  This group “creates probes and other neuro-technology for clinical applications and labs around the world.”  The company expects sales from Neuronexus, would be around $5 million in 2016.  I don’t get the sense that the business will be a huge revenue driver, but their research gives insights into the latest developments in neuro-stimulation.

So there is a lot of innovation, and hopefully some of that innovation translates into revenue growth.  Its not a perfect investment case of course, none of my ideas are; there is a cash drain, there is plenty of competition, and there are insurance approval hurdles that could take months.  I am prepared for a lumpy ride, and as usual I have kept my position small until I can see sales get more traction.

Nevertheless, if they prove that they can meet their goal of $1-$1.5 million in sales per territory in the next year or two, the stock should trade at a decent multiple to revenue, which is multiples of what its trading at now.  And the cash drain will be no more.

Taking a position in a recent IPO moonshot: Ichor Holdings

Over the last couple of weeks I spent my spare time listening to presentations from the Needham conference.

Most of what I heard was pretty boring.  A few were from companies that I own (Radcom, Radisys, DSP Group, Oclaro, Nimble and BSquare) and I adjusted a few of my positions upon review (I reduced Radcom a little, added to Oclaro).  But most were new companies that I haven’t heard of before.

I was on the lookout for a good idea and I think I found one.  The company is called Ichor Holdings.  They provide fluid delivery systems for semi-conductor equipment manufacturers.  In particular they produce two products, one a gas delivery sub-system and a chemical delivery sub-system.

The stock was an IPO in December (here is the prospectus).  The IPO went for $9, which was a steal.  It’s over $15 now, which means its traded up significantly.

I bought some at $14.  I haven’t mentioned the stock until now because I kept waiting for a correction so I could buy more (well it came briefly one morning when it dipped into $12’s for a couple minutes but I was at work and not available – argh).  So now it broke out and I’ve given up.  I probably am rushing this write-up out a little, but given the move in the stock I feel like if not now then maybe never.

So you are looking at a stock here that is up almost 50% in the last couple of months.  Caveats apply.  Nevertheless, here’s what I think, why I bought it at $14 and you can choose if you want to wait for a correction or not.

There is a narrative for not waiting.

There are two big players in the outsourced semi-conductor equipment market that manufacture fluid delivery sub-systems: Ichor and Ultra Clean Holdings.  These are fairly similar companies.  I think that Ultra Clean also does some more general component manufacturing and Ichor has a chemical delivery business, but overall the two companies are comparable.

Ichor and Ultra Clean compare favorably based on TTM results.

ichor1

Everything seems reasonable so far.  But here is where it gets interesting.  Both companies pre-announced very strong fourth quarter revenues in the last few weeks.  Here is Ichor’s announcement and here is Ultra Cleans.

Ichor’s revenue growth in the fourth quarter was a rather incredible 104% year over year.  There was a small acquisition (Ajax, which contributed $13.4 million in revenue since it was acquired in April 2016) that brought the company into the chemical delivery business but apart from that it was all organic growth.  Ultra Clean had an impressive 67% year over year growth.  Again, organic.

Ichor said that revenue in the first quarter would exceed the fourth quarter.  So we have at least three more months of this tremendous growth.

There are a couple of takeaways from Ichor’s and Ultra Clean’s Needham presentations (here and here) that help explain the growth.  First, both are benefiting from decent wafer fab equipment demand growth, around 6%.

Second, as chip complexity increases and moves to “multiple patterning, tri-gate, or FinFET, transistors and three-dimensional, or 3D, semiconductors” (eg. 3D NAND), deposition and etch sub-systems growth becomes even stronger (Ichor says 15%).  Each layer that is added to the chip requires another etch, deposition and CMD step.  Ichor says this dynamic in the market only began in the second half of last year and is “still in the early innings”.  The following is a slide from Ichor’s presentation:

ichor2

Finally, their customers, the OEM process tool providers (LAM, Applied Materials, etc), are outsourcing more of the equipment manufacturing, so Ichor and Ultra Clean are gaining share that was previously held by their customers.

Ichor has the added bonus that they are growing their chemical delivery business at an even faster rate.  I think that the acquisition of Ajax earlier this year brought them into the business, but they may have had a small footprint prior.

The chemical delivery business (via Ajax) was a single digit million revenue business a few years ago but has grown 10 fold the last few years.  They currently have 10% market share so there is room for further growth.

Ichor doesn’t provide a detailed breakout of revenue between their gas delivery and chemical delivery businesses but did say at Needham that Chemical was about one-ninth of revenue and they could see it getting to one-third.

The other consideration that applies for both companies is the business model has good leverage to revenue increases.  While Ichor was a little vague on this, only saying that they have a “variable cost structure that drives highly leveraged earnings model”, and that their operating costs remain relatively flat as revenue increases, Ultra Clean was more specific, providing the following table in their slide deck at Needhams:

ichor3So I took a reasonably sized position at $14.  I’m willing to watch how this plays out over the next few months.  But I look at this as more of a trade.  If the stock gets up to $20 in the next couple months, I’ll be a seller.

The thing is, I don’t know how long this cycle is going to continue.  It will turn.  I haven’t done a lot of work on the semi-equipment cycle and I don’t even know where to start to determine when that inflection occurs.  And surely the kind of revenue increase we saw in the fourth quarter isn’t going to continue forever.

Nevertheless, with the fourth quarter numbers that Ichor has guided to, they are trading at well under 10x EBITDA (I didn’t run any scenarios yet so I can’t say exactly where I think that ends up).  They are an IPO, which means they are under-followed and probably being estimated conservatively by analysts.  And they have already forecast at least one more quarter of significant growth.   So the runway is clear for another few months.  I’ll look forward to any pullback.