CEVA - CEVA: Improvement And Potential Headwinds Show Up At The Same Time

2023-11-12 23:20:22 ET

Summary

• The stock has done poorly for a long time, but a 20+% gain since the start of November has raised hopes CEVA may have hit bottom.
• The recent rally was made possible by several factors and the near-term outlook in the latest report calls for a return to growth.
• While CEVA is optimistic, there are a couple of headwinds out there that could negatively affect the company in a number of ways.
• CEVA has been hot in November, but the stock is at risk of dropping about as fast as it has gone up in recent weeks.

People had every reason to head into the latest report from CEVA ( CEVA ), a licensor of IP for wireless connectivity technologies, smart sensing and other solutions, with some trepidation. The stock suffered big losses after each of the previous two earnings reports, which did not bode well for the Q3 FY2023 report on November 8. In addition, the stock went on a major rally prior to the report’s release. However, while the stock dropped once again, losses were fairly moderate this time around, in part due to an outlook calling for a return of growth. Yet CEVA may not yet be in the clear as other headwinds could be out there to play spoiler. Why will be covered next.

The Q3 FY2023 report was a mixed bag

A previous article from August rated CEVA a hold after the stock missed estimates by a mile, in part due to unexpected setbacks. The article also cautioned that even though the stock was already at multi-year lows, the stock was at risk of falling to new lows. As it turned out, CEVA did proceed to hit new lows, including as recently as October 31.

Still, the stock did not sell off as much as it did after the two prior releases with a loss of 3.6% on November 8, but the Q3 report was nonetheless a mixed bag. Non-GAAP EPS was better than expected, but revenue came in lower than expected at $24.1M, a decline of $19.9% YoY and the fourth consecutive quarterly decline. Licensing, NRE and related revenue totaled $13.9M and royalty revenue contributed $10.1M. In terms of GAAP, CEVA finished with a loss of $5M or $0.21 per share.

However, CEVA has recently sold its Intrinsix unit, which it acquired just two years ago, to Cadence. If Intrinsix is excluded and only continuing ops are included, then GAAP loss was $2.75M or $0.12 per share. Similarly, non-GAAP profit was $0.02 per share, but if only continuing ops are included, then non-GAAP profit was $0.06 per share. The disposal of Intrinsix is the main reason why gross margin shot up in Q3, back to the nineties where it used to be before Intrinsix brought it down. CEVA ended Q3 with cash, cash equivalents, securities and bank deposits of $132M with no debt. The table below shows the numbers for Q3 FY2023.

Source: CEVA

Furthermore, management alluded to an end to the recent downturn and a return to growth as soon as 2024. Q4 revenue is forecast to come in at $23.3-25.3M, which, while small, represents a sequential increase at the midpoint. Using this datapoint from CEVA, Q4 non-GAAP EPS is estimated to come in at $0.06. From the Q3 earnings call:

“Now, turning to our outlook. CEVA, post divesting its Intrinsix's AMD service business will be able to present GAAP to non-GAAP accretive financials for 2023 compared to its previous consolidated financials and excluding the ongoing losses from its discontinued operation.

Our gross margin will increase and get back to the 90-ish percentage level, cost of revenue and OpEx will also decrease, respectively. Overall, we are actively on measures to reduce overall headcount and expensive and monitor them closely in parallel to investing, enhancing marketing and licensing of our technologies.

Our licensing and related revenue business has shown improvement in the third quarter, and we see a promising pipeline ahead of us for wireless connectivity and sensing AI technologies.

In royalties, we anticipate consumer products and low-cost smartphone to maintain demand ahead of the upcoming holiday season, and we'll continue to monitor the 5G base station RAN market for any improvements. All-in-all, we expect fourth quarter overall revenue to be in the $23.3 million to $25.3 million range.

Looking ahead, into next year 2024 and considering the investment on the Intrinsix service business, we would use the basis of the fourth quarter guidance for modeling 2024 with potential revenue growth as the year progresses.”

A transcript of the Q3 FY2023 earnings call can be found here .

There is reason for optimism. Shipments data suggest demand, which has given CEVA all sorts of problems, is starting to come back. Shipments by licensees increased by 35% QoQ and 40% YoY to 500M units in Q3 FY2023, up from 370M in Q2 FY2023 and 357M in Q3 FY2022. Handset baseband chips contributed 79M units, flat QoQ, but base station and IoT products contributed the remaining 421M units, up 45% QoQ and 51% YoY. Bluetooth held the biggest share with 313M, an increase of 103M units compared to a year ago.

Is the bottom finally in?

As mentioned earlier, the stock rallied in the days leading up to the release of the Q3 report and while the stock did drop initially, the stock recovered to close at $19.90 on November 10, not far from where it closed before the release of the Q3 report on the 8th. CEVA thus retains most of the stock gains after it hit a multi-year low of $16.38 on October 31. The chart below shows how the stock has fared in the last 12 months.

The stock has lost 22.2% YTD, but it has also gained an impressive 21.5% in less than two weeks following the October 31 low. Granted, the stock was heavily oversold after the recent drop. The stock market also went on a powerful rally during this time and a rising tide lifts all boats. Still, it’s worth mentioning that the stock declined for close to three years, from the February 2021 high of $83.95 to the October 2023 low of $16.36.

The last time the stock price got any lower than the October 2023 low was in November 2014 or nine years ago. With the stock hitting lows not seen in many years, it stood to reason the stock was due for a bounce, which did happen with the stock gaining 21.5% following October 31. However, the question now becomes whether the decline of recent years has truly ended and the stock has finally hit bottom or whether the recent rally will peter out for the decline to resume.

Why there may be potential headwinds out there for CEVA

While management may be optimistic about growth in the near-term, there are a number of reasons why the stock may not yet have hit bottom. For starters, CEVA is a company primarily based in Israel and while the recent outbreak of hostilities has yet to impact the company in a meaningful way, it is possible that may still happen, especially if the conflict expands to other regions and other actors decide to take part in the conflict.

If this happens, the stock could resume the selloff of recent years. In addition, there may be another headwind to keep an eye on. As shown earlier, CEVA is rather heavily exposed to Bluetooth and Wi-Fi to a lesser extent. It’s therefore worth mentioning that a new wireless standard called NearLink has started to appear in consumer devices in China.

Like Bluetooth and Wi-Fi, NearLink is a short-range wireless connection technology. On paper, NearLink could supplant Bluetooth and Wi-Fi to a lesser extent, especially since NearLink has a number of advantages compared to Bluetooth and Wi-Fi, including power consumption, speed and latency.

Device makers currently need to add support for both Wi-Fi and Bluetooth as the two complement each other, but by only using NearLink, device makers can simplify the design of the device as only one technology is needed instead of two separate ones, which simplifies and streamlines the design and reduces costs.

If NearLink gains adoption, a supplier of IP related to Bluetooth and Wi-Fi like CEVA could stand to lose out since the IP would no longer be required or at least not as much. Keep in mind that many of CEVA licensees are Chinese companies, which accounted for 56% of FY2022 revenue according to the most recent Form 10-K.

On the other hand, NearLink has yet to take off, unlike Bluetooth and Wi-Fi which are now ubiquitous. It is possible NearLink may fail to gain wide adoption despite its superior specs. For instance, NearLink was developed primarily by Huawei and other Chinese companies, which could be why certain countries will be unwilling to back the new technology even if it turns out to be as good as claimed.

Still, while it depends on what happens to NearLink in the coming years, it’s fair to say that CEVA has a potential headwind in the form of NearLink to be on the lookout for. In the worst case, NearLink replaces Bluetooth and Wi-Fi in most of the devices where they are currently used. Obviously, this would not be in the interest of CEVA.

CEVA may be above fair value

Fair value is a highly subjective term. The need to make forward projections means there is a possibility the numbers used may turn out to be way off. Nevertheless, an argument can be made that CEVA is trading above fair value. The discounted cash flow method, for instance, is one of most often used methods used to calculate fair value. Assuming CEVA grows much faster than it has in recent past, and revenue grows from $116M to $203M in the next five years, resulting in free cash flow increasing from $732K to $15.4M and with an estimated discount rate of 9.86%, then it can be argued that fair value for CEVA is around $11.80.

Keep in mind that the above numbers may be an underestimate and CEVA may grow much faster than the numbers above assume. Still, if the above turns out to be accurate, some people are likely to conclude that CEVA is overvalued despite the recent drop in the stock price. It also doesn’t help perceptions that multiples, which many people use for reference, are very much on the high side. For instance, CEVA has a forward non-GAAP P/E ratio of 262. In terms of GAAP, CEVA does not have one because the company is in the red. There are a number of reasons why some may shy away from CEVA.

Investor takeaways

The stock has rallied in the last two weeks after hitting a low not seen in nine years. This rally was made possible thanks to several factors, including being way oversold. However, the stock has slowed down in recent days and there is reason to ask whether the recent rally was just a temporary bounce before the decline of the last few years resumes or whether CEVA has hit bottom and the stock is now looking up.

CEVA itself is optimistic growth will soon return and the shipment data does suggest demand is getting better. On the other hand, there are a couple of headwinds out there that could greatly affect CEVA in numerous ways. There is a war going on and that could have severe repercussions for CEVA, depending on how the conflict unfolds.

The potential rise of competing technologies could disrupt CEVA’s business model, which involves the licensing of IP to other companies. CEVA is heavily exposed to the Bluetooth market and the Wi-Fi market to a lesser degree, but superior standards could replace them. This could have serious consequences for CEVA in the long run.

I am neutral on CEVA. While there are some encouraging signs like the recent shipment data, there is a lot to be concerned about. There is after all a reason why the stock has spent the better of three years in decline. Valuations for CEVA were on the lofty side and some could argue that has not improved all that much, despite the big drop in the stock price of recent years.

Bottom line, while some may want to bet that the stock can continue the rally of the last two weeks, others may want to take note of the various risks associated with a stock like CEVA. CEVA is facing a couple of major challenges, including one that could drop the stock in the blink of an eye. It doesn’t have to be that way, but if it does, one will be glad to have dodged a bullet.

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