“Meet the Company Behind Apple’s Incredible Profit Surge” (Robert Hsu Teaser Deciphered)

Sniffing out the teased "No. 1 China Recommendation" from Hsu for his China Strategy newsletter

We haven’t looked at a pick from Rober Hsu’s China Strategy in quite a while — and it’s not just that we’re ignoring him, as far as we can tell InvestorPlace has not been promoting his newsletters very actively over the last six months or so.

Which probably isn’t a huge surprise — China stocks have not been media darlings of late, and the investor unease over several China stocks that have been “outed” as frauds or simply beaten down because they smell a little fishy has most likely been a strong deterrent for subscribing to a newsletter that aims to recommend Chinese stocks. Heck, despite the fact that dozens of them look like drop-dead bargains I’ve been studiously avoiding Chinese small cap stocks — even the ones that I’ve profiled in the past for the Irregulars.

(At least two of the picks I featured for the Irregulars in recent years have later reported accounting problems or suffered bear raids from short sellers, including some stocks I owned personally … I say that just to be clear that I’m not standing above the fray here, I have been burned by China stocks, too).

But Robert Hsu isn’t pitching China, per se — which is probably wise — he’s pitching something that is far more popular on Wall Street right now: an Apple supplier.

And of course, it must do its manufacturing in or near China — everybody else does, too, since most of the globe has ceded low-cost manufacturing to the Middle Kingdom. And if you avoided stocks that did a lot of business in China you’d also avoid … well, Apple (AAPL). Which would, I think, be foolish. So let’s dig in and try to figure out who Rober Hsu is teasing this time around, shall we?

“If you’re looking for one reason why Apple’s quarterly profits nearly doubled, you’ll find it here in this little-known flash-drive supplier that’s not only riding the iPhone/iPad/smartphone frenzy to new heights but also outperforming Apple on Wall Street where it counts the most: investor profits….

“Surprisingly, the biggest profittaker of Apple’s iPhone growth surge isn’t Apple.

“It’s a little-known company that is profiting from Apple’s pumped-up demand for flash memory, which has not only sent this company’s profits soaring but also delivered even bigger profits during the smartphone boom—237% vs. Apple’s 146% over the past two years.

“That’s why, today, I’m going to give you the full details on this behind-the-scenes money doubler, with my compliments, before I release the name to the public and it delivers another 38% earnings surprise and rises another 237%. That way, you’ll be able to get in on it before it soars again.”

The story Hsu is pitching seems to be all about flash memory — the little memory chips that are in your iPhone and iPad to store your movies and your copy of Angry Birds and whatever else it is that you absolutely must have at hand at all times. This is the same kind of memory that has made Sandisk rich (sometimes) over the years, and it’s also what’s in the memory chip for your camera or the little USB flash drive that you might carry around or have as an attachment on your Swiss Army Knife if you happen to be super nerdy, circa 2006.

And the basic idea is that the huge demand for Apple products means flash memory providers should be rolling in it (money that is, not memory chips) — here’s how he puts it:

“Because Apple’s profit surge and record iPhone sales have triggered a shortage of flash memory across the entire industry. With more and more companies adopting flash memory to run their mobile, phone, and other computing devices, the supply demand squeeze will only create even bigger profits for our top-rated company.

“This is why this company has outperformed Apple by 91% percentage points over the past two years—as Samsung, HTC, and others have tried to make their phones more iPhone like.

“So it’s no wonder why this company has the highest buy rating on Wall Street and Fidelity, American Century, and other top small-cap growth funds own millions of shares of this company.”

And if you click through to the order page, you get one more little clueish tidbit:

” I want the name of your No. 1 recommendation that’s making more profits on smartphone sales than Apple…

When this company’s technology comes to the U.S., you’re going to see this company’s 69% revenue growth double in the blink of an eye, as it will give U.S. consumers the carrier choices they have always wanted.”

Which makes me think they updated that revenue growth number, but didn’t actually look at the text of the paragraph (maybe an intern was working on the web updates that day). That bit about “giving US consumers the carrier choices they have always wanted” is almost certainly a holdover from the stock Hsu teased in the last widely-promoted campaign we wrote about back in November — that was Spreadtrum Communications, the stock teased by both Hsu and his colleague Louis Navellier as a barnburner because they made chips that allowed you to use three SIM cards or one phone and thus shuttle back and forth between providers. Incidentally, he also compared that one to Apple, saying it was “like buying Apple in 1997.”

I suppose it’s possible he’ll end up being right on that one … but I’m not betting on it, and it’s been a lousy pick over the last six months (it jumped up after earnings last week, but is still down about 50% since we wrote about that teaser).

So will this latest Apple-connected teaser suffer the same fate? Well, we tossed all those clues into the Thinkolator — and believe me, it was a light load (flash memory company, stock has beaten Apple, some mutual fund holders to match, 38% earnings surprise, and maybe, if they updated the number, 69% revenue growth). But the Thinkolator is quite mighty, indeed, and up to the challenge — our answer? Hsu is almost certainly teasing Silicon Motion (SIMO).

Which did report 69% revenue growth in the fourth quarter of 2011. And did surprise on the upside by 38% in that same quarter. And they are in the flash memory business, though it’s as designers of flash memory controllers, not manufacturers of the memory itself (like most small cap semiconductor companies, they are “fabless” — they market, design and sell their own proprietary chips, but they outsource manufacturing). Here’s how they describe themselves on their website, in case you didn’t have enough acronyms for breakfast today:

“Silicon Motion is the global leader and pioneer in developing microcontroller ICs for NAND flash storage devices and specialty RF ICs for mobile devices. Our products are widely used in many of the leading smartphones and other mobile devices in the market today. More NAND flash products, especially next generation flash, whether produced by Samsung, SanDisk, Toshiba, Micron, Intel or Hynix, are supported by Silicon Motion controllers than any other company. Silicon Motion leads the industry in supplying innovative controllers for managing the latest generation TLC (3-bits per cell) and the most advanced process geometry NAND flash. We are a leader in memory card and flash drive controllers and are increasingly focused on eMMC and SSD controllers for smartphones, tablets, and notebook PCs. Silicon Motion is also a leading mobile TV IC solutions provider and a leading provider of wireless transceivers for 4G LTE smartphones and tablets. We market our Mobile Storage and Multimedia SoC products under the “SMI” brand and Mobile Communications products under the ‘FCI’ brand.”

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According to this brief note from Robert Hsu

But it’s rarely good news for investors who own the stock when you’ve got articles being published with the headline, “Why Silicon Motion Technology Tanked,” as we saw two weeks ago from SIMO when they reported first quarter earnings.

Earnings which were, by the way, really, really good — the “tank” was because the CEO told everyone to expect a lousy second quarter. Hsu clearly was more optimistic about this one, here’s what he said in a note from January that’s part of a free preview:

“Ma’s victory sends a strong message that the people of Taiwan want continued economic cooperation with Mainland China, which bodes well for Taiwanese companies such as technology chip designer Silicon Motion Technology Corp. (NASDAQ: SIMO), a nice winner for our portfolio. Since we bought it last October, the stock is up about 55%, and I believe that it still has further upside this year. As such, I want to raise our buy-limit in the stock to $24 with a target of $30. I will look for other potential opportunities in Taiwan for us in the coming months.”

So he said that on January 19, and there have now been two quarters reported since then — both solid beats of analyst expectations — but he didn’t need to raise his buy limit, the stock never quite reached $24 (it was around $22 when he wrote this), and it has come down pretty steadily over the last five months, culminating in the last lousy ten days or so of trading that have put the stock at about $13.

Which is a shame, really — great earnings and revenue momentum and still a horrible stock to own for six months. Why? Well, as you might guess, it’s all about that forecast — I don’t know if management is lowballing, but they’re expecting revenues to grow 20-30% in 2012 from 2011, and that there will be some weakness in the second quarter as demand for memory cards and the like is weak (though they think part of that will be made up for by the fact that they have some design wins for LTE chips, especially with Samsung, and by increased SSD shipments that increase demand for their SSD controllers … SSD stands for Solid State Drives, the much faster “flash” alternative to hard disk drives that’s getting some traction in computers now).

Here’s how the CEO, Wallace Kou, put it in that quarterly press release:

“Retail demand for memory cards and end demand for smartphones sold with bundled cards–other than those sold by certain OEMs–have been weak. We expect this weakness to impact our business in the second quarter. However, increasing sales of our New Growth Products should offset this weakness. We are excited about the ramp of our new eMMC controllers with our NAND flash partner and its smartphone OEM customers, as well as the continued growth of our Samsung LTE business. We expect our eMMC business with another NAND flash partner to begin mass production in late second quarter.”

“For the Second quarter of 2012, management expects:

— Revenue to be up 0% to 10% sequentially
— Gross margin (non-GAAP) to be in the 48% to 50% range
— Operating expenses (non-GAAP) of approximately US$17 to US$18 million”

So … there you have it. Right now, if you think Robert Hsu is right about the potential of this company, you can buy it a lot cheaper than he did — and, frankly, if they’re right about their margins and their growth for 2012 it is indeed a cheap stock in a segment that ought to have pretty decent trends (mobile chips for LTE and flash controls, chips for controlling SSD), with a forward PE of about 6, a trailing PE of 9, and almost $100 million in net cash on the books. I don’t know a lot about the business, how management has performed in the past, or what the competitive landscape is like for flash controllers, but that’s pretty cheap for a company that analysts think will still grow earnings by 30% this year and 10% more the following hear — if they’re just downshifting to a somewhat lower growth rate due to lack of demand for a few products, perhaps it’s now an opportunity to take a look.

I should note, however: though the shares did beat AAPL handily over the trailing two years if you took your measurement early in 2012, that’s certainly not the case any more — and AAPL, though it’s more than 1,000X larger and carries a higher PE valuation (13 vs. 9 trailing, 10 vs. 6 on forward estimates), is (according to the analysts) going to grow earnings significantly faster than SIMO both this year and next. So you can take that however you want to.

P.S. For what it’s worth, I had similar thoughts about some Apple suppliers and other tangential plays on the new mobile world last Summer and eventually (quite late, actually, I can be stubborn) had the epiphany, “why am I doing all this work to track down lesser-known stocks and suppliers and possible winners when Apple itself — the one company I know for sure will profit from Apple’s success — is cheaper, safer, and growing faster than most of those other companies?” That’s why Apple has become one of my larger holdings in the last year. Not that I’m sure it will beat out SIMO going forward, it certainly should be easier to grow fast for a fly than it is for a fly fisherman, just sharing my thoughts.

Full disclosure: Apple is one of my largest personal holdings, I do not own any other stock mentioned above and won’t trade any covered stock for at least three days.


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