SILC - Silicom - Poised To Pop

• Silicom ended Q2 with the highest backlog in company history.
• Products redesigned for component availability coming to market in Q3.
• Prior big inventory build will support growth in H2 and beyond.

Silicom ( SILC ) is on the verge of a fresh wave of revenue growth. Large design wins over the past year (see my detailed article here ) concurrent with supply chain issues have led to the largest backlog in company history. The company is poised to capitalize on this backlog with redesigned products hitting this quarter and previously built inventory being used to satisfy demand. Trading at only 1.2x 2023 revenue and 7.7x 2023 cash earnings the company's stock is ready for liftoff.

Silicom's revenue cycle with a customer begins with a design win where the customer decides to use a Silicom product and gives Silicom a forecast of estimated revenue over time. Usually Silicom does not report design wins unless an initial purchase order is in hand. I have owned stock in Silicom for 15 years (since the company was doing only $20 million a year in revenue) and in the old days design wins were small, in the $2-$5 million range. As the company has grown and increased its addressable market, design wins have grown in size. For example in November 2021, Silicom announced a $50 million per year design win with a Tier-1 US telecom company. This followed a design win in October which the company said would make that customer its largest over time. Having these design wins gives investors some sense in advance how revenue will grow in the future.

This cadence of design wins turning into revenue was slowed by the semiconductor shortage which followed the Covid pandemic. Silicom reacted quickly to this challenge in two ways. First, it began redesigning some high throughput products for component availability. It tested these products throughout the first half of 2022 and many of the most important ones have recently gone into volume deployments. Second, the company built a large inventory of the harder to find components so it could fulfill a greater portion of demand starting in Q3. This will lead to a guided 13% sequential jump in revenue in Q3 and perhaps an even larger jump in the seasonally strong Q4.

A recent tweak to the story came in a smaller design win announced earlier this month. A $3 million purchase order was received by Silicom from a fast growing US SASE player. SASE stands for Security Access Service Edge which is a rapidly growing subsector of the cybersecurity market. Previous to this design win, most Silicom edge devices were used to provide SD-WAN (Software Designed Wide Area Networking). This is also a rapidly growing space but might end up with a smaller addressable market than SASE. Zscalar ( ZS ) is the market leading SASE player and it is growing revenue at a 60% clip. With its carriage tied to both the SASE and SD-WAN horses, Silicom might repeat its growth surge for 2009 - 2013 where its almost quadrupled its revenue.

I am not modeling such extreme growth (at least not yet), but I do think Silicom can grow at a 25% pace for a number of years. If 2023 revenue grows 25% from 2022, Silicom will only be trading at 1.2x sales and 7.7x cash earnings. This P/E ratio is obviously untenable for a company growing 25% per year and the stock will rerate higher on a higher earnings number. At 20x earnings plus the $14.50 per share in net cash the company will have by then gets you to a $102 price target or 143% higher than current levels.

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