- Highlights that SIMG trades at 48% -
116% discount to sum-of-the-parts valuation
- Identifies significant unrealized value
and robust balance sheet obscured by bloated cost structure that is
approximately 2000bps higher than peers
- Asserts that valuable 60 GHz assets are
not reflected in current market value and act as a drag on
earnings
- Calls on SIMG Board to cut costs,
aggressively repurchase shares, and take action to unlock the value
of the Company’s assets
Engaged Capital, an investment firm specializing in small and
mid-cap North American equities and beneficial owner of
approximately 5.2% of the common stock of Silicon Image, Inc.
(“SIMG” or the “Company”) (Nasdaq:SIMG), today sent a letter to the
Company’s Board of Directors (the “Board”).
The full text of the letter follows:
December 22, 2014
Members of the Board of DirectorsSilicon Image, Inc.1140 East
Arques Ave.Sunnyvale, CA 94085
Gentlemen:
As you know, Engaged Capital has been a significant shareholder
of Silicon Image, Inc. (“SIMG” or the “Company”) for over a year.
We have recently increased our position and now own approximately
5.2% of the Company’s outstanding shares. We believe that SIMG has
highly valuable assets and technologies which are currently
underappreciated by the market and when valued on a
sum-of-the-parts basis, are worth between 48%-116% more than the
Company’s current share price. Further, we believe the decisions
and actions that are required to unlock this latent value are under
the full control of the Board and management team and must be
immediately taken.
Highly valuable HDMI
business
We believe the Company has a highly valuable High-Definition
Multimedia Interface (“HDMI”) franchise that is obscured by the
complexity of SIMG’s business. In particular, the IP licensing
operation provides a highly stable and profitable foundation for
the Company’s business and valuation. Generating over $50 million
in annual revenue with gross margins of approximately 99%, this
business is a significant contributor to both earnings and cash
flow. We believe this revenue stream will remain stable over time
as a significant portion of these revenues are derived from HDMI
applications. In addition to this licensing revenue, SIMG generates
over $80 million in consumer electronics product revenue, the
majority of which is derived from HDMI products. This revenue
stream has increased 38% YTD and has grown by over 30% in each of
the last four quarters. Yet, the market does not appear to properly
value the HDMI franchise which is lost in the Company’s complex
business structure.
Bloated Cost Structure
We believe the Company’s profitability has been negatively
impacted by a bloated cost structure more suitable for a much
larger company. SIMG’s operating expenses are nearly 50% of sales,
which is approximately 2000bps higher than well run semiconductor
peers, which operate with expenses closer to 30% of sales. SIMG has
the responsibility to materially increase profitability and create
substantial shareholder value by reducing operating expenses and
right-sizing the Company’s cost structure.
A material reduction in costs, beyond
initiatives already announced by the Company, would greatly expand
margins, earnings, and cash flow, even after taking into account
the expected 10% revenue decline in 2015 driven by weakness in the
Mobile High-Definition Link (“MHL”) business. As illustrated in the
chart below, despite generating substantial revenues, we believe
SIMG’s MHL business is only marginally profitable, if profitable at
all, due to the Company’s excessive operating expense structure. As
such, by properly managing its expenses, SIMG should experience
only a minimal change in profitability even if the MHL business
were to weaken further (see hypothetical “Downside Scenario”
below). 1 While we believe this operating expense reduction
opportunity was present prior to the recent MHL disappointment, the
expected decline in 2015 revenues highlights the necessity to
aggressively address the Company’s historical cost issues.
DownsideScenario
2014E 2015E Mobile
Product Revenue $ 98 $ 68 $ 25
Growth
(30 %) (74 %) Gross Profit $ 48 $ 33 $ 11
Gross Margin
49 % 48 % 45 %
Opex
$ 43 $ 30 $ 9
% Sales
44 % 43 % 35
% EBIT $ 5.1 $ 3.2 $ 2.5 Margin 5.2 % 4.6 % 10.0 %
Mobile Product EPS $ 0.05 $
0.03 $ 0.02
Hidden Value in 60 GHz Wireless
Assets
Based on feedback from industry participants and competitors, we
believe SIMG’s 60 GHz wireless assets have significant unrealized
value. The Company’s closest 60 GHz peer, Wilocity, was recently
sold to a strategic acquirer for close to $400 million. In
addition, numerous leading technology companies including Qualcomm,
Intel, Broadcom, and Samsung have announced plans to develop 60 GHz
wireless capabilities over the past year, further validating the
value of 60 GHz technology. We applaud the recent decision by the
Company to place SIMG’s 60 GHz assets into a separate, wholly owned
subsidiary, and believe this move expands the options available for
these assets and provides greater flexibility for a range of
strategic outcomes.
Despite holding tremendous potential value, we
believe the 60 GHz assets currently have a negative impact on
SIMG’s valuation due to the significant earnings drag caused by
R&D investments in this technology with little to no offsetting
revenue. We believe this investment represents a ($0.15) loss per
share headwind and estimate the Company’s earnings per share would
be over 65% higher excluding this investment.2 Strategic actions
with these assets would not only deliver significant value, but
would also materially improve the Company’s profitability. It is
critical that the Board thoughtfully yet urgently flesh out a
strategic path for the 60 GHz assets and execute on it successfully
and quickly to deliver the greatest potential value for
shareholders.
2015EEPS
SIMG Total $ 0.23
60 GHz Drag
($0.15 ) SIMG ex-60 GHz $ 0.39
% Increase ex-60 GHz 67 %
Valuation
There is a severe disconnect between SIMG’s current market value
and the value of the Company’s assets. To illustrate how large we
believe the discount is, we share a summary of our valuation below.
As you can see, we believe that even in a worst case scenario,
SIMG’s stock is trading at almost a 50% discount to the sum of its
parts.
2015E EPS Multiple
Valuation Low
Base Low
Base Low
Base IP3 $ 0.25 $ 0.30 11.0x 13.0x IP $ 2.75 $
3.92 Mobile4 $ 0.02 $ 0.03 4.0x 8.0x Mobile $ 0.09 $ 0.23 CE5 $
0.04 $ 0.05 9.0x 12.0x CE $ 0.36 $ 0.63 60 GHz6 ($0.15 ) ($0.15 )
60 GHz $ 1.29 $ 3.22
Qterics7
Qterics
$ 1.29 $ 1.29
Cash Cash $
1.91 $ 1.91
Total SIMG $ 0.16 $ 0.23
Total SIMG $ 7.69
$ 11.20 Current Price $ 5.19 $ 5.19
% Upside
48 % 116 %
Due to the severe undervaluation and significant cash balance,
currently almost $150 million, the Board has the opportunity and
responsibility to create additional shareholder value through
proper capital allocation. If the Board is truly confident in the
Company’s plan towards unlocking significant value, we encourage
the Company to aggressively repurchase stock at current prices
which are well below the intrinsic value of SIMG’s assets.
We appreciate the opportunity to share our views with the Board
and management team over the past year. We look forward to
continuing our discussions on the opportunities available to unlock
the significant value that exists in SIMG’s assets. However, if the
Company’s current Board and management team continue to be unable
to unlock this value, we must exercise our rights as shareholders
and consider the nomination of new directors for election at the
upcoming annual meeting.
Sincerely,
Glenn W. WellingManaging Member
About Engaged Capital:
Engaged Capital, LLC, (“Engaged Capital”) was established in
2012 by a group of professionals with significant experience in
activist investing in North America and was seeded by Grosvenor
Capital Management, L.P., one of the oldest and largest global
alternative investment managers. Engaged Capital is a limited
liability company owned by its principals and formed to create
long-term shareholder value by bringing an owner’s perspective to
the managements and boards of undervalued public companies. Engaged
Capital manages both a long-only and long/short North American
equity fund. Engaged Capital’s efforts and resources are dedicated
to a single investment style, “Constructive Activism” with a focus
on delivering superior, long-term, risk-adjusted returns for
investors. Engaged Capital is based in Newport Beach,
California.
1 2014E and 2015E are EC estimates based on SIMG guidance.
Downside case is EC estimate assuming a significant decline in MHL
revenue and a corresponding reduction in operating expenses as % of
sales. 2 2015E EPS is EC estimate derived from SIMG guidance for
4Q14 and 2015 revenue and margin guidance. 2015E 60 GHz investment
is EC estimate based on company public comments. 3 Base case
assumes flat revenues from 2014. Low case assumes ~15% decline in
revenue. Assumes operating expenses are ~40% of sales. Multiples
based on EC estimates. 4 EC assumptions based on SIMG guidance (see
Mobile table from above for details). Multiples based on EC
estimates. 5 Base case assumes minimal revenue growth from 2014.
Low case assumes return to 2012 revenue levels. Assumes operating
expenses are ~43% of sales. Multiples based on EC estimates. 6
Assumes $100 million valuation in Low case and $250 million
valuation in Base case. 7 $100M valuation based on recently
announced $7 million investment by Qualcomm for 7% of business.
Bayfield Strategy, Inc.Riyaz Lalani,
416-907-9365rlalani@bayfieldstrategy.com
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