CEVA: A Good Time To Buy

Editor's notes: With a big 2015 looming as it enters non-mobile markets, CEVA is priced for gains. Tech fund manager Edward Schneider sees a potential double over the next 18 months.

Based in Mountain View, CA with R&D in Israel, CEVA (CEVA) designs/licenses digital signal processor (DSP) cores and platforms primarily to the mobile industry. DSPs mathematically modify and improve signal quality, including the conversion of analog signals to digital, and vice-versa. CEVA mainly serves the mobile phone baseband market, but is increasing its footprint in wireless infrastructure (M2M), audio, imaging, and automotive.

CEVA is the #1 licensor of DSP cores and platforms, three times larger than its closest peer. 5B CEVA-powered devices have been shipped to date, including 900M handsets in 2013. CEVA has Intel (INTC), Broadcom (BRCM), Samsung (OTC:SSNLF), Infineon (OTCQX:IFNNY), and other major semiconductor companies as licensees, with the notable exception of Qualcomm (QCOM) and MediaTek (2454.TW) for now. Several years ago, then market-leader, Texas Instruments (TXN), closed its external DSP business, creating an opening for CEVA. Since then, DSP requirements have become increasingly onerous and expensive for semiconductor manufacturers to maintain, leading most of them to outsource their DSP chip design to CEVA.

CEVA has a highly profitable and scalable business model based on royalties on every unit shipped (either fixed at $0.03 per unit on average or ~1% of chip price), and upfront license fees and support. Royalties accounted for 54% of 2013 revenues, and licensing 46%. The beauty of CEVA's ~90% GM business model is that incremental gross-margin revenue from royalties falls to the bottom line.

CEVA's high-growth trend was interrupted in 2012-2013 by 1) declines in cheap 2G mobile phone sales where CEVA had dominant market share, 2) related declines in 2G mobile royalties to $0.01 - $0.02 per unit, 3) Nokia (NOK) business decline whose mobile phones used CEVA DSP cores, and 4) the delayed launch of low-cost smart phones. In the second half of 2013, however, sub-$100 3G smart phones were introduced in China for as low as $30, which bodes well for 2014. Baseband growth in low-cost Chinese smartphones (e.g. Samsung's Galaxy models selling for $35) should be CEVA's largest growth driver in 2014. A second growth driver is the 4G LTE market which only has 2% penetration today. Samsung and Intel are now shipping multi-mode smartphones powered by CEVA. Also, the recent MediaTek acquisition of Via, a CEVA client, may help CEVA break into MediaTek for LTE chips.

CEVA, $M	2010	2011	2012	2013	2014e§	2015e§
Licensing Revenues	18.4	20.2	19.1	22.4	25.0	26.0
Royalty Revenues	22.9	36.4	32.0	26.5	28.0	40.0
Total Revenues	44.9	60.2	53.7	48.9	53.0	66.0
Gross Profit	41.2	56.7	49.7	43.7	48.0	61.5
as % of revenues	91.7%	94.1%	92.6%	89.4%	90.6%	93.2%
EBITDA	10.4	19.1	12.9	5.4	14.0	22.0
as % of revenues	23.2%	31.7%	24.0%	11.1%	25.9%	33.3%
Non-GAAP EPS	0.56	0.97	0.79	0.54	0.84	1.10
GAAP EPS	0.51	0.77	0.59	0.30	0.60	0.86

* includes other revenues of $3.7M in 2010, $3.6M in 2011, & $2.6M in 2012; §Consensus: 2014 revs: $51.5M, 2014 GAAP EPS: 0.60, 2014 EBITDA: $14M, 2015 revs: $58M, 2015 EBITDA: $19M, 2015 GAAP EPS: 0.76

A long-awaited growth driver for CEVA has been penetrating non-mobile sectors, which diversifies its revenue base into some secular growth areas. The only problem is that these niches pale in size to the mobile baseband business. Finally, CEVA appears to be making some real progress in this area by announcing a larger-than-expected number of broad-based licensing wins in Q4 2013. Eight of the eleven 2013 Q4 licensing deals were non-baseband in fast-growing markets, and apart from two Bluetooth deals, had premium royalty potential. Also, the average dollar value of the non-baseband deals was in line with the baseband deals.

CEVA's 2013 Q4 could be a turning point. Total revenues of $14M rose 40% sequentially, and 8% y-o-y. Royalties advanced 11% sequentially from a Q3 trough to $6.7M, after a long downtrend that started in 2012 Q1. Licensing revenues in Q4 were a record $7.3M, up 84% sequentially and 52% y-o-y. Licensing revenue momentum continued into the month of January. Licensing revenue eventually turns into royalty income. Thus, medium-term visibility to rebounding revenues and profits improved dramatically.

CEVA is by no means out of the woods. Management guided down consensus estimates for a seasonally soft 2014 Q1. CEVA's 2013 Q4 handset exposure was 60% feature phones and 40% smartphones. While feature phone exposure decreased from over 70% at the beginning of the year, CEVA is still sensitive in the short term to feature phone market erosion, as well as smartphone launch delays. But by the time this short-term volatility issues disappear, CEVA stock should be much higher than today. Not surprisingly, CEVA shares jumped 10% in the first two trading days after CEVA reported before the open on January 30, and have roughly maintained those gains since then. This is the first-leg in what could be a larger rebound after the Street gets on board.

The tipping point is still a ways off, but visibility is improving. Aided by non-mobile phone baseband applications and low-cost smartphones, the number of CEVA-powered devices will move from 3B in 2012 to 7B in 2016 according to management. 4B incremental devices x $0.03 average royalty rate = $120M in revenues that drop to the bottom line. This would have a major impact on CEVA with just $49M in 2013 revenues.

How much upside does CEVA shares have from here? I see 2015 as a break-out year for CEVA, well above the consensus forecasts. I am less certain about 2014 as there are still some handset transition issues that can weigh on CEVA's 2014 results. Viewed another way, CEVA stock was trading above $30 in January 2012 when revenues and EPS peaked at $60M and 0.77, respectively. I am forecasting a strong rebound in 2015, with revenues of $66M and EPS of $0.86. CEVA shares are at $17.22 today, they would double over the next 18 months using the same multiples and growth rates that the market applied to CEVA two years ago.

The risk that management can control is execution. CEVA needs to continue licensing momentum to build a diversified yet robust base for sustainable long-term growth. The uncontrollable variable is the mobile phone market - will Samsung (CEVA's customer) continue to gain market share at the expense of Apple (AAPL)? In any case, if management fails or the market disappoints, CEVA will be penalized by its stock-based compensation program that takes a big chunk out of years with weak profits like 2013. In other words, CEVA's prospects today have to be that much stronger to compensate for an aggressive ESOP relative to its current small net profit base.

Currently priced at $17.22, CEVA shares have a market cap of $379M, and after deducting net cash and equivalents of $134M, have an enterprise value of $244M. CEVA shares rose 13% year to date, after declining 3% in 2013 and dropping 48% in 2012. CEVA shares are fully valued on an absolute basis using 2013 figures, trading at EV/revenues of 5.0x, EV/EBITDA of 45.0x, and a P/E of 57.4x. Based on 2015 figures, the numbers are more attractive with EV/revenues of 3.7x, EV/EBITDA of 11.1X, and a P/E of 20.0x. CEVA is attractively valued versus its direct peers. The premium valuations of CEVA and its few public peers are merited in light of their well protected, scalable and profitable royalty/licensing business model. ARM Holdings and Immersion are the most direct comparisons, while Imagination Technologies had major operational shortfalls in 2013 and has a more levered balance sheet.

CEVA's unique, protected and profitable business model was coveted by Wall Street in 2010-2011, and will be attracting similar interest again as positive trends initiated in Q4 2013 become more prevalent. What is not in the price today, are watershed results starting next year. The Street will need further confirmations of positive 2013 trends that became more pronounced in Q4. Some investors are looking at current subpar royalty revenues (which actually reflect customer sales from the previous quarter). But by the time that analysts tweak their models/price targets and royalties rise, CEVA shares should be much higher. While it is not a lock, recent positive operating trends should continue as 1) positive licensing momentum continues into the current quarter, and 2) today's licensing revenue strength turns into future royalty streams. Thus, CEVA has an attractive risk-reward tradeoff.

By Edward Schneider

Source:http://seekingalpha.com/article/2038623-ceva-a-good-time-to-buy