2023-06-06 12:57:56 ET
Summary
- Immersion Corporation has impressive profitability metrics but lacks sustainable revenue growth and is overvalued.
- The company has a strong balance sheet but an unclear capital allocation strategy and insignificant R&D investments.
- IMMR faces risks from foreign currency fluctuations, compliance in multiple countries, and unsustainable revenue growth.
Investment thesis
Immersion Corporation ( IMMR ) demonstrates nearly impossible profitability metrics. The gross margin has been close to 100% in recent quarters, and the operating margin is impressively far above 40%. But I prefer not to invest in this stock because it lacks the most important metric that it should demonstrate as a growth stock. According to consensus estimates, the company does not have a sustainable revenue growth path and is not expected to in the next two fiscal years. My valuation suggests that after a solid 12-month rally, the valuation looks unattractive at current levels.
Company information
IMMR is a licensing company focusing on inventing, accelerating, and scaling haptic technologies that allow people to engage with products and experience the digital world around them. The company adopted a business model under which it offers licenses for patented technology to customers. This enables software, related tools, and technical assistance to integrate the patented technology into customers’ products.
The company's fiscal year ends on December 31, with only one segment reported to management. The company generates a vast portion of its sales outside of the U.S. Revenue generated in South Korea and Japan represents about 60%. From a market areas perspective, the central part of sales relates to mobile, wearables, and consumers.
In the Mobile, Wearables, and Consumer IMMR's licensees include giants like Samsung, Google ( GOOG ) (GOOGL), Sony (SONY), and Panasonic. The company's licensees included Microsoft ( MSFT ) within the Gaming Devices Market.
Financials
If we look over the long-term financial performance of IMMR, we can see that metrics were very volatile with no clear path.
As you can see, last year's revenue is about three times lower than its peak in FY 2018. The extraordinary spike in FY 2018 revenue was due to the adoption of a new revenue standard effective January 1, 2018. I want to emphasize it to explain to readers that 2018 was not a year of stellar business performance.
Licensing business is highly profitable because you have low costs, and we can see that margins are very high. The levered free cash flow [FCF] margin has been very volatile, making it much harder to project future earnings. Therefore, earnings estimates are available only for the next two years, and the forecast does not look bright with negative revenue and EPS dynamics.
IMMR's balance sheet is strong, with almost no debt and substantial liquidity ratios. IMMR does not pay dividends but repurchased $13.5 million of its shares in FY 2022. The capital allocation strategy looks unclear to me because the company accumulated a substantial amount of cash on its balance sheet, and it neither reinvests in the business growth nor distributes dividends. R&D investments also were insignificant in recent quarters.
Revenue declined during two straight quarters, which proves soft consensus estimates for the upcoming years. The forthcoming quarter's revenue is expected at $7.76 million by consensus estimates, which is about 3% lower YoY.
The company recently initiated litigation against Valve to protect its intellectual property. IMMR claims that the gaming stream service allegedly infringed on several patents. IMMR has a rich history of litigations that started at the beginning of the century. The company has taken Apple ( AAPL ), Microsoft, Sony, and Facebook ( META ) to court to protect its intellectual property. A 2004 litigation against Sony was a huge success since the court found the Japanese giant liable for patent infringement and awarded Immersion $82 million in damages. Therefore, I believe there is a probability that the court case against Valve might be successful and bring significant one-off income to the company.
Valuation
The stock demonstrated almost no growth year-to-date; however, it currently trades significantly below this year's April highs. As you can see on the below chart, the stock trades much closer to its historical minimums rather than maximums.
I use discounted cash flow [DCF] to value growth companies like IMMR. We will have a very high level of uncertainty regarding the underlying assumptions due to volatility in the company's historical financial metrics. Gurufocus suggests that IMMR's WACC is about 13%, which I consider fair. We have revenue consensus estimates available only for the two upcoming fiscal years. For years beyond, I implemented a 7% revenue CAGR. FCF margin has been very volatile historically, but I expect it to be at 15% in FY 2023 and to expand by two percentage points each year. Assumptions are very optimistic, in my opinion.
Incorporating all the above assumptions into the DCF model returns me a fair value of the business below $200 million, meaning the stock is substantially overvalued.
The stock has a relatively high Seeking Alpha Quant valuation grade of "B+", but I cannot agree with it. IMMR currently trades at about 7 forward sales, substantially higher than its 5-year average and much higher than the sector median.
Risks to consider
The company generates most of its revenue outside the U.S., which means IMMR is exposed to numerous risks. Operating in multiple countries means dealing with foreign currencies. Fluctuations in exchange rates can affect a company's revenues and profitability. Aside from exchange rate risks, operating in different countries also increases compliance risk. The nature of the licensing business is that legal risks are inherently high. And running such a business with high legal risks in other countries means you multiply the inherent risk's impact. Each country may have rules and standards that the industry must comply with. Changes in regulations, tariffs, or trade barriers could increase operating costs or hinder market access, negatively impacting sales growth and company profitability.
Unsustainable revenue growth is also a considerable risk for me. IMMR has licensing agreements with giants like Google, Microsoft, and Japanese electronics behemoths, so I see little room for sustainable long-term revenue growth. The market seems saturated with haptic technology licenses if there are no signs of growth in the next two years. Another reason why the company demonstrates unstable revenue dynamics might be the inherent lack of scalability.
Bottom line
To conclude, IMMR stock is not an attractive investment opportunity in my view. The stock is overvalued, according to my valuation analysis. Moreover, for a growth company, it is crucial to demonstrate to investors a clear path of revenue increases. IMMR's historical revenue record has been very volatile, and consensus estimates expect the next two years to be without revenue growth. I do not invest in this stock and assign it a neutral rating.
For further details see:
Immersion Corporation: Growth Stock With Stagnating Revenue