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Stock Screen: Growth Stocks with Moderate Risk - October 10, 2012
This screen is designed for investors seeking stocks with worthwhile long-term appreciation potential and low-to-moderate risk. We began by screening for companies where share earnings have compounded at a minimum 15% annual rate over the past five years and that are expected to at least maintain a 10% annual growth rate over the next three to five years.
Next, we limited the list to stocks with price appreciation potential of 90%, or more, over the next three to five years, measured from the mid-point of each issue’s projected Target Price Range. Companies scoring our lowest rank, 5, for Safety were excluded. We also required that each company have a Financial Strength rating of B or better. Of the list of stocks that meet those criteria, we believe CEVA, Inc. (CEVA) warrants consideration.
Israel-based CEVA is a licensor of silicon intellectual property (SIP), primarily for makers of handsets (all cellular standards), tablets, eBooks, game consoles, set-top boxes, etc. Its licensees are semiconductor and OEM companies that use the IP to design their own differentiated baseband chipsets (modem and DSP, explanation below) including: Broadcom (BRCM), Intel (INTC – Free Intel Stock Report), Marvell (MRVL), MediaTek, PMC-Sierra (PMCS), Samsung, Sony (SNE), Spreadtrum (SPRD), ST Ericsson, and Toshiba, among others.
The company’s principal IP architectures are used by its customers to develop various digital signal processing (DSP) cores with varying performance, power requirements, and prices. This silicon converts an analog signal (such as the human voice or music) into digital form (a stream of numbers) which permits voice and audio compression (a mandatory feature for saving memory space and allowing more users to share the scarce frequency band in wireless communication). The digital audio signal is then converted back to analog so it is once again audible to humans.
CEVA typically charges lump-sum, upfront licensing fees to semi designers for access to its technology (33.6% of 2011 revenue). It also charges royalty fees (around 1% of the chipset price, currently averaging around $0.03) to phone makers that include these chips (60.4% of revenues). Importantly, CEVA’s royalty revenues inked in any given quarter come from phones sold in the quarter immediately prior. Its top three customers accounted for 12%, 16% and 17% of total revenues in 2011.
Facing pressure to make devices smaller, less expensive, and more energy efficient, a number of semiconductor designers are choosing to license complex DSP technology from proven sources like CEVA, rather than develop it in-house, in an attempt to quicken the design process and reduce overall time to market.
In 2011, CEVA’s licensees shipped more than one billion CEVA-powered chipsets, an increase of 68% over 2010 shipments of 613 million ICs. Specifically, there were 2.2 billion cellphones sold, and around 900 million (~40%) of them were designed with CEVA’s DSP blueprints. The overwhelming majority of these handsets were 2G phones from Nokia (NOK) and Samsung that were sold in emerging regions like China, India, Latin America, and Africa (the company has about 60% of the worldwide 2G market).
The major reason why the stock price is down 55% year to date and testing its 52-week low is because the global cellphone market is transitioning away from 2G feature phones, toward 3G smartphones at a quiicker pace than originally expected. Currently, CEVA’s market share in 3G handsets is only around 25%. Baseband powerhouse Qualcomm (QCOM) has around 45% of the baseband market (Strategy Analytics) and has not been licensing CEVA’s DSP technology for 3G basebands, instead, choosing to develop its own. However, companies like Intel (15% of the baseband market), Broadcom, ST-Ericsson, and Spreadtrum are more likely to use CEVA's less-costly, third-party DSP technology, and are aiming to increase baseband volumes for lower-cost 3G handsets from Huawei, ZTE, Nokia, Samsung, and Chinese “white-label” vendors. The non-Qualcomm baseband suppliers have started winning more low-end designs and are even getting a greater portion of the high-end 3G market. For example, CEVA technology is included in the popular Samsung Galaxy S3 device via the Intel X-GOLD 626 PMB9811 baseband processor.
The company expects the worldwide 3G subscriber base to balloon from the current 1.4 billion, to 3.2 billion by 2015. We believe this should allow CEVA to grow its market share to a point near current 2G levels (~60%) over the next two years. Also, 3G chip prices are more than double that of the 2G variety, so royalty revenues may well benefit from both increased average selling prices and higher volumes. The same thesis holds true for 4G subscribers, which were 12 million in 2011 and are widely expected to exceed 700 million by 2015. The company is already in 20 LTE designs, some from the likes of Samsung, which is designing them internally. LTE should start to ramp meaningfully in 2014.
In essence, CEVA provides a way for investors to capitalize on the growing number of low-end 3G baseband suppliers and their increasing share of that rapidly expanding market. Still, it may take another few quarters before low-end 3G smartphones start fully replacing 2G feature phones. Although the historically low valuation, strong cash balance, and zero debt, may limit downside risk at this juncture, the stock will probably remain rangebound until evidence of increased 3G sales in emerging markets materializes. Therefore, these small-cap, growth-oriented shares will likely interest patient investors.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.