The Motley Fool has really been ramping up their weekly “Investor Digest” ads that focus on pitching their higher-end portfolio services, and we’ve covered several of those in the past few weeks… but lots of readers keep asking, so we’ll throw another one on the pile today. What’s this “Small-cap 5G stock” they’re pitching?
Ahh…. 5G… it almost makes me feel nostalgic for the good ol’ teaser pitches of two years ago, when 5G was all anyone could talk about. It got a little bit lost in the shuffle with the pandemic and the explosion of SPACs and space stocks and sports gambling and all kinds of other sexycool ideas, but it’s still out there. A transition to a new wireless standard is still a big deal, it still drives a lot of infrastructure buildout, new demand for equipment (including new phones), and, as that faster service becomes more available, it will presumably drive new innovative products that take advantage of it (remember before 4G, when you couldn’t even reliably watch videos on your phone?) Technology evolution takes some time, even discrete upgrades like 4G to 5G, but it’s clearly coming… so what’s the stock the Motley Fools are touting as a play on that?
Here’s the tempting bait they dangle:
“The Motley Fool made its name by finding transformative stocks targeting huge growth…
“Before everyone else saw the opportunity.
“And every now and then, even in this market, our analysts uncover a true under-the-radar small-cap stock with what we think is a huge growth story to tell.
“Well, Jason Moser has done just that over at Extreme Opportunities: Next-Gen Supercycle.
“This stock is exclusive – it hasn’t received a formal recommendation anywhere else at The Motley Fool.”
I’m pretty sure we haven’t looked at that Next-Gen Supercycle product from the Fool yet, but it’s basically the same idea as their other Extreme Opportunities services — they offer up a set portfolio that has already been recommended, with updates along the way as they add new stocks to it, rebalance the portfolio, and cover the updates to those stories, and, unlike the “entry level” Motley Fool stuff it’s nonrefundable (and pricey, the “on sale” offer is currently $1,399 for the first year and will auto-renew, retail price is $1,999). The Lead Advisor for this one is Jason Moser, who also helms the Extreme Opportunities: Augmented Reality service.
This is how they position the service, if you want more detail:
“Now, with 5G phone sales projected to be 60-fold by 2023…
“And a coming wave of 5G infrastructure buildout experts believe will cost $275 billion in just the U.S. alone…
“AND 5G projected to have a global impact of $17 trillion in sales by 2035…
“I trust you can see why we’re so excited about this market!
“Which may bring up another question in your mind: “What kind of returns are we targeting?”
“Lead Advisor Jason Moser and his team are aiming to build a diversified portfolio – containing stocks of different potential risk and upside – that they believe can achieve 6X to 7X growth across the next decade!”
So before ponying up $1,399 for a nonrefundable subscription you want all the info you can get, right? Let’s at least get a name for that “huge growth story” stock they’re pitching, and you can look into it, think it over, and make your own call… without the “take me to the stock!” pressure that leads people to pull out their credit cards and make rash investment decisions. The more info, the better, right?
I’ve mentioned this before, but one of the key areas were our brains get in the way is in buying stuff — if you buy a house, you keep checking on other home sales in your neighborhood so you can congratulate yourself on getting a big deal… if you buy a car, you look for good reviews of it to make you feel smart… and if you pay big bucks for a newsletter, you are incentivizing yourself to invest heavily in whatever stock they’re teasing to get you to sign up. If you pay $1,399 or $4,999 or whatever (nonrefundable, naturally) to learn about a secret stock, then once you read the secret report and get your “tip,” your brain is not going to want you to decide it’s a dumb stock idea. That would mean admitting that you just purchased something without thinking.
So that’s part of why we do what we do here — if you already know the name of the stock, and you didn’t pay for it, you’ve got a much better chance at being rational and disciplined in trying to analyze it and decide whether you want to invest.
But what, then, is this stock? Here are our final clues…
“The company made $100 million last year… in a fast-growing slice of the 5G market….
“It’s not ‘just’ a 5G stock…it’s a 5G stock with what Jason calls a ‘really attractive’ business model that sports 89% gross margins….Are you getting our free Daily Update
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“A genuine small-cap… sub-$2 billion market cap small.”
Which means that the Thinkolator can take a day off, kick up its feet on the chaise, and wait for a bigger challenge — all we need here is a stock screener to tell us that with revenues near $100 million, gross margins near 89%, and a market cap under $2 billion, this is… Ceva (CEVA)
CEVA currently sports a $1.5 billion market cap, is unprofitable but has a 89% gross margin, and reported exactly $100 million in top-line revenue over the past four quarters. A perfect match, and there actually aren’t any other matches that are even close. And if you want a little confirmation, the Motley Fool disclosures indicate that they did not recommend the stock a few months ago, but they did recommend it as of about a week ago, when CEVA’s latest earnings call transcript was posted. (And you should read that transcript if you’re interested in the stock, it gives the company’s basic outlook on where they stand right now.)
So what does this company do? It’s a little bit like Rambus (RMBS) or Universal Display (OLED) in that it’s primarily an IP company, they own valuable patents and do basic R&D in their niche, and make money by licensing those patents and doing joint ventures with customers to advance new technologies and support new products. Rambus specializes in memory, Universal Display in OLED screen technology, and CEVA in signal processing. Here’s how they describe themselves:
“CEVA is the leading licensor of wireless connectivity and smart sensing technologies. CEVA’s technology portfolio includes digital signal processors, AI processors, wireless platforms and complementary software for sensor fusion, image enhancement, computer vision, voice input and artificial intelligence, all of which are key enabling technologies for a smarter, connected world. More than 10 billion CEVA-powered chips have shipped to date for a wide range of diverse end markets.”
The biggest driver is sales volume for wireless products that pay royalties or license fees for CEVAs IP, particularly in Bluetooth and WiFi. Here’s the quote from CEO Gideon Wertheizer from their quarterly press release last week:
“We are very pleased to end the year with another excellent quarter, in both licensing and royalties. We concluded 21 licensing agreements, including a strategic and comprehensive agreement with a top tier smartphone OEM who will develop a range of CEVA-based connectivity chips to serve its smartphone and wireless accessories product lines. Our record high royalty revenue reflects a particularly strong quarter in smartphone shipments and continued traction in our base station and IoT product category, which grew 50% year over year.”
They also do call out the big sales boom last year in several products that helped to drive revenue growth, so growing demand for things like 5G base stations, smart TVs and laptops all helped CEVA last year. On the surface, their fourth quarter was relatively weak, with both GAAP and non-GAAP revenue and earnings below where they were in 2019, but it was WAY better than analysts had been predicting so the stock surged on earnings day last week… though it has since given up those gains. The full year was pretty strong, at least on the top line, with revenue up 15% (non-GAAP income was up 2-3%).
The company is in fine shape, given their high gross margins and relatively low operating expenses, so they don’t have any need for capital — they have about $130 million in cash and no debt. The challenge is in figuring out whether they’ll be able to grow again and to get back to consistent profitability (they’ve been a publicly traded company for more than 20 years, and have only failed to make a profit in three of those years). Over time it has worked out reasonably well, here’s how CEVA (blue) has stacked up over the past 18 years or so compared to the Nasdaq 100 (QQQ, in orange) and the iShares Semiconductor ETF (SOXX, red):
The growth is not looking particularly overwhelming, here’s an excerpt of the guidance they gave in that earnings call last week — which sounds qualitatively good, but represents only 6% revenue growth (perhaps just because they’re being a bit conservative on the royalty forecast):
“Now for the guidance, we expect 2021 to be another growth year for CEVA as the momentum in our business continues. We are forecasting total revenue to be just over $106 million — $106 million for 2021 with growth in both royalties and licensing. Specifically, in regard to royalty revenue forecast, we are taking a wait and see approach, as the semiconductor industry has experienced extended lead times for chip orders and lean inventories, which we expect to last through the first half of the year.
“Our licensing business continues to be solid with growing opportunities in 5G, Wi-Fi 6, TWS earbuds and automotive, as Gideon earlier elaborated earlier. We are targeting another record year for licensing, which will set the stage for additional new streams of royalties in the years to come. On the royalty front, we are expecting a decline in royalties from a leading smartphone OEM, who has switched to another baseband supplier for its recently launched 5G smartphone lineup.
“With that said, we do maintain our presence in its 4G smartphones that are still expected to ship volume this year. We also see continued progress for our China-based customer, who has recently regained good momentum in low cost smartphones for emerging markets, and has also recently launched its first CEVA-powered 5G chip in China. In our base station and IoT product category, we expect to continue to outgrow the markets we are targeting. Overall, we believe that new royalty growth drivers will more than offset the decline in royalties from the 5G smartphone supplier switch.”
The stock has generally been upgraded by analysts over the past week or so, following the very strong earnings report — presumably because of the record high royalty revenue that gives some hope of a boost in scalability (since royalties are typically based on volume). Estimates now are that they will report adjusted earnings per share of 60 cents for 2021, about the same as last year, and then a 10%+ jump in revenues in 2022 that will bring earnings to 89 cents a share. If you want to use a fairly optimistic look, then, that means, at $65, that we assume they will grow earnings by 45%, and we’re paying about 70X those earnings.
If they are able to reach those goals, and keep that growth up, it’s likely to work out just fine for investors… but that is an “if.” There’s some reason for optimism, it sounds like there’s a good chance that new product introductions, particularly around new wireless standards (like 5G and WiFi6) and rapidly growing products (like the newest iterations of headphones), will provide a meaningful boost. The challenge I’d see is that they’ve pretty dramatically increased their operating and R&D costs over the past few years, partly through acquisitions, and they are looking at a real possibility for a couple weaker quarters to start 2021, because of semiconductor logjams and a little post-holiday lull in new product introductions, so it’s not at all certain that they’ll be able to grow revenue or earnings in the next couple quarters.
On the “feelings” side, qualitatively, I feel pretty good about CEVA’s chances — the numbers aren’t there right now to justify this share price, but with a new product cycle still settling in for 5G and WiFi6 and the likelihood of pretty strong design wins in their space from new customers as wireless products continue to proliferate, I’d guess that they’re in pretty good shape to return to growth that’s a little bit stronger than analysts are currently expecting. I’d hope to see a bit more of a pullback, given the possibility that the first half of this year could be pretty soft for them in terms of revenue growth as the chip business detangles itself and new product launches and volume shipments get back on track, but my instincts drive me toward thinking about buying shares.
Of course, I haven’t bought shares at this point… and I said some similarly positive things about CEVA last April, when it was being teased as one of the 5G (or 15G, he said) stocks by George Gilder, and I didn’t buy it back then, either (more’s the pity, it’s up more than 100% since then, like so many other tech stocks).
So that’s what we’ve got for you today… not a super challenging stock to find, but a tough valuation to get your head around after that big surge the shares enjoyed in January. High margin, slow growth, high potential that both the company and analysts seem to want to remain a bit conservative about at this point.
That’s just what I think, though, and it’s your thinking that matters — it is, after all, your money. Tempted by CEVA? Have other 5G favorites that light your fire? Am I missing something fantastic in this story, or being too optimistic? Let us know with a comment below… thanks for reading!